Many broker-dealers, RIAs and recordkeepers have been struggling with whether the participant disclosure rules apply to asset allocation models (AAMs). The Department of Labor has now issued guidance on this issue in Field Assistance Bulletin 2012-02.
In that guidance, the DOL addressed whether an AAM that is presented to plan participants as an asset allocation strategy among investment alternatives is a designated investment alternative or “DIA.” The significance of that question is that detailed information about DIAs must be provided to participants under the participant disclosure rules (404a-5), including the DIA’s expense ratios and performance history and a website describing the DIA’s principal strategies, risks and portfolio turnover rates. Even though this obligation is imposed on the ERISA plan administrator (typically, the plan sponsor or the plan committee), in many instances the plan administrator will look to its service providers for this information. To complicate matters, most service providers (e.g., recordkeepers) do not have systems that can capture and report the information about AAMs for those disclosures – and will not be able to do so for many months or perhaps even years – which could cause plan fiduciaries to be out of compliance.
Unlike investment education models (under DOL Interpretive Bulletin 96-1) that educate participants on ways of managing their own accounts, an AAM is presented to plan participants as an investment tool that allows them to allocate their accounts among the plan’s investment line-up by simply electing to use the AAM’s allocations. On occasion, AAMs may also include investment alternatives not available for participant selection under the plan. Most AAMs also have a rebalancing feature so that, after market fluctuations cause the allocations to change, the accounts are periodically restored to the original allocations. The question addressed by the DOL is whether an AAM is considered an investment subject to the disclosure rules governing DIAs, rather than merely an allocation service.
The DOL guidance on AAMs is addressed in a question which uses, as its example, a plan that offers 10 investment choices and three risk-based model portfolios comprised of different combinations of the plan’s investment options. The DOL states that an AAM “ordinarily” is not required to be treated as a DIA if it is clearly presented to participants as a way of allocating among the plan’s investment options and a description of how it functions and how it differs from the plan’s investment options is provided to participants. This is good news for advisors that offer an AAM using only the core line-up. We refer to an AAM of this type as a “qualifying asset allocation service” because it is not viewed as an investment. It is important to note, though, that several conditions must be satisfied for the asset allocation service to “qualify,” that is, to avoid DIA status.
But what about AAMs that allocate among investments that are not otherwise available to participants? The DOL response is not as clear as we would like; for example, at one point it says: “if a plan offers only model portfolios made up of investments not separately designated under the plan, each model would have to be treated as a designated investment alternative.” While this statement could be read to mean that, if the AAMs have some investments from the core line-up and some “outside” investments, the AAMs are not DIAs, we believe there is risk in that interpretation. For example, the first sentence in the answer says: “A model portfolio ordinarily is not required to be treated as a designated investment alternative under the regulation if it is clearly presented to the participants and beneficiaries as merely a means of allocating account assets among specific designated investment alternatives.” Because of that statement, we believe the safest interpretation of the DOL’s intent is to require DIA status if any outside investments are used in the AAMs.
In conclusion, service providers, such as broker-dealers, RIAs, and recordkeepers who offer AAMs should restructure them as qualifying asset allocation services in order to avoid DIA status. For those advisers who want to use outside investments in participant accounts, one option is to offer such services as a 3(38) investment manager. If structured properly, the asset allocations of a 3(38) investment manager will avoid DIA status. The restructuring process should include reviewing all written and website material descriptions of the managed account services to make sure they are consistent with the DOL guidance.