On August 22, 2008, the U.S. Department of Labor (“DOL”) published proposals to implement the “eligible investment advice arrangement” exemption enacted in section 601 of the Pension Protection Act of 2006 (“PPA”). The proposals were reflected in three documents:
- A mandated report to Congress finding that there are “computer model” investment advice arrangements available to IRA’s that satisfy the requirements of the PPA;
- A proposed regulation elaborating the statutory “level fee” and “computer model” exemption applicable for both ERISA plans and, in light of the conclusions reached in the report to Congress, IRAs. This exemption conditionally allows “fiduciary advisers” to provide investment advice to plan participants and IRA beneficiaries that might bear on the economic results of (i) affiliates of the adviser, so long as the compensation to the adviser does not vary with the participant’s investment choices; or (ii) the adviser itself, so long as the advice is provided by a computer model meeting certain requirements; and
- A proposed ERISA class exemption supplementing the statutory exemptions by permitting “off-model advice” and additional organizational structures for “level fee” arrangements.
Comments on the proposals are due by October 6, 2008.
Report to Congress
DOL concluded that there are computer model programs available to IRA’s that (i) utilize relevant information about the IRA beneficiary; (ii) take into account the “full range of investments, including equities and bonds,” in recommending options for the IRA investment portfolio; and (iii) allow the IRA beneficiary sufficient flexibility in obtaining advice to evaluate and select investment options. In reaching that conclusion, DOL read the PPA to require that the computer model take into account “all of the generally recognized asset classes that are necessary for an account beneficiary to construct a diversified investment portfolio,” and need not consider the “full universe” of every investment legally available to IRA’s (which commentators asserted, without contradiction, was not feasible).
The proposed regulation is summarized in the chart starting on page 4. The proposal largely follows the language of the statute and the positions taken by DOL in FAB 2007-71. In addition, DOL was responsive to some but not all of the advance commentary it received pursuant to its December 2006 request for information or otherwise. Among other notable aspects of the proposal:
- The proposal does not further elucidate the exemption provided by the statute for plan sponsors and certain other fiduciaries.
- The proposal does not speak to the circumstances in which investment activity is deemed to occur “solely at the direction” of the participant or IRA beneficiary – a predicate of the exemption.
- An advice arrangement may rely on a combination of the level fee and computer model approaches.
- For level fee arrangements, the proposal adds a requirement that the advice be based on generally accepted investment theories that take account of historic returns of different asset classes over defined time periods. (The statute imposes this condition on computer models.)
- For both level fee and computer model arrangements, the proposal requires the investment advice to take account of information furnished by the participant relating to age, life expectancy (about which participants may not always be reliably informed), retirement age, risk tolerance, other assets or sources of income (which not all advice programs are currently designed to reflect), and investment preferences.
- The proposal makes it clear that the computer model exemption is available for plans that offer only investment options proprietary to the investment adviser.
- The rules for a computer model contemplate the development of asset allocation portfolios from available investment options – a concept that, at least for IRAs, might benefit from further clarification in the final regulation.
- The certification required for computer models can apply across similar applications of a model for multiple plans and IRAs; i.e., a separate certification is not required for the advice arrangement as applied to each plan or IRA.
- A number of important requirements for compliance with the regulation – such as the manner in which a computer model is to satisfy certain specifications, the qualifications of the independent expert that certifies a computer model, the methodology utilized in that certification, and the scope and methodology for the annual audit – are addressed in this advance guidance only generally, and are left for advisers to determine in connection with their programs and for the regulators and courts to judge after the fact.
- DOL undertook to balance the potential burdens of the annual audit requirement:
- The audit is to address all the adviser’s investment advice programs with ERISA plans and IRAs, and all the advice provided under those programs; but
- The auditor is to be selected by the fiduciary adviser, is allowed to have other engagements with the fiduciary adviser subject to certain limitations, and may rely on sampling techniques.
- The delivery of securities law disclosures required by reason of the participant’s investment choices – a condition to qualify for this exemptive relief – is framed as a responsibility of the fiduciary adviser; in practice, other parties often are responsible for delivering those disclosures.
- For a variety of purposes, the regulation introduces the concept of a “material affiliation” or “material contractual relationship” among certain parties. While this threatens a return to a variation of the “party in interest” tree, it may be that the circumstances in which these concepts apply are sufficiently focused that the rules will be workable.
- Since the exemption extends to all the advice provided under the advice programs, the usual ERISA recordkeeping requirement under this exemption may warrant particular attention.
- This guidance reiterates that the SunAmerica approach remains available under ERISA for investment advice arrangements.
The regulation would take effect 60 days after publication in final form.
Proposed Class Exemption
DOL proposes to resolve two important issues arising under the statutory exemption through the issuance of a class exemption.
The proposed class exemption would significantly expand 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 would be helpful to financial service business structures where the investment advice function and the investment product manufacturing function must be integrated in a single corporate entity. The proposed class exemption also would allow a fiduciary adviser to provide individualized investment advice following the furnishing of recommendations generated by a computer model or (with respect to IRAs where the fiduciary adviser determines that computer modeling is not feasible in light of the number and types of investment choices available) certain investment education. Additional conditions would apply to such “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 independent party (in which case the certification requirement does not apply):
- 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.
Otherwise, the proposed class exemption generally incorporates the conditions applicable to the statutory exemptions. In addition, 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 class exemption would be 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 exemption.
The proposed class exemption would take effect 90 days after publication in final form.