Both ERISA and the Internal Revenue Code generally prohibit an investment adviser from recommending an investment to participants in participant-directed individual account plans that would cause the adviser, or a person or entity in which the adviser has an interest that may affect the exercise of the adviser’s best judgment as a fiduciary, to receive an additional fee as a result of the investment. The Pension Protection Act of 2006, however, amended both ERISA and the Internal Revenue Code to add a statutory exemption to permit an adviser to give investment advice through an “eligible investment advice arrangement,” provided the adviser itself does not receive an additional fee as a result of the investment (unless the advice is given through a computer model). In late February 2010, the U. S. Department of Labor published proposed regulations on providing investment advice to participants in section 401(k) and other individual account plans, as well as individual retirement accounts and certain similar plans, through eligible investment advice arrangements. The purpose of these regulations is to protect participants from receiving investment advice that is tainted by the investment advisers’ financial conflicts of interest, such as advice that unfairly favors an adviser’s own products or that will provide the adviser with additional compensation. (The DOL previously published final regulations on this issue, but they were withdrawn before becoming effective in response to concerns that they did not adequately protect participants from receiving biased advice.)

The key provisions of the new proposed regulations are generally the same as those contained in the withdrawn regulations. As before, the new regulations do not invalidate previously issued exemptions or interpretive guidance (including the “SunAmerica” model that permits an investment adviser to provide advice through a computer model developed by an independent third party). Specifically, as required by the statutory prohibited transaction exemption, advice provided by a “fiduciary adviser” through an “eligible investment advice arrangement” must be provided under either:

  • a computer model; or
  • a “level fee” arrangement under which the adviser’s fees (including any commissions or other compensation) for investment advice or for security transactions do not vary based on the investment options selected by the participant.

The new proposed regulations contain a number of safeguards designed to help ensure that investment advice given to participants is unbiased. If the regulations are finalized as proposed:

  • All eligible investment advice arrangements would have to be selected by plan fiduciaries independent of the fiduciary adviser and its affiliates.
  • In the case of a level fee arrangement, the fiduciary adviser and any of its employees, agents and registered representatives that provide investment advice would be prohibited from receiving (directly or indirectly) any fees or other compensation from any party (including from affiliates of the adviser) based in whole or in part on a participant’s selection of an investment option. (Affiliates, however, would not be prohibited from receiving fees, etc. that vary based on the participant’s selection.)
  • The fiduciary adviser must engage an independent auditor, at least annually, to conduct an audit of all eligible investment advice arrangements for compliance with the DOL’s rules.
  • The fiduciary adviser must provide plan participants, without charge, with an advance, written notification of, among other things: (i) the role that parties affiliated with the adviser (or contractually related to the adviser) played in the development of the program and in the selection of investment options; (ii) historical performance data for the available investment options; and (iii) details of how (and from whom) the adviser is compensated.
  • In the case of computer model advice, the computer model would have to be certified as unbiased by an investment expert who satisfies certain qualification requirements and has no material affiliation or material contractual relationship with the fiduciary adviser, with its employees, agents, registered representatives and affiliates, or with certain other parties.  

The new regulations also contain an optional model disclosure form that could be used to satisfy the notification requirement described above.

These proposed regulations are not binding, and the DOL anticipates that the effective date of these requirements will be 60 days after the regulations are finalized. Comments on the proposed regulations will be accepted through May 5, 2010, indicating that the regulations will likely not be finalized until the second half of 2010.