STATEMENT OF THE AMERICAN COUNCIL OF LIFE INSURERS
BEFORE THE SUBCOMMITTEE ON EMPLOYER-EMPLOYEE RELATIONS
OF THE COMMITTEE ON EDUCATION AND THE WORKFORCE
UNITED STATES HOUSE OF REPRESENTATIVES
ON
THE RETIREMENT SECURITY ADVICE ACT OF 2001 (H.R. 2269)

TUESDAY, JULY 17, 2001

I. Introduction

My name is Jon W. Breyfogle and I am testifying on behalf of the American Council of Life Insurers ("ACLI"). I am a principal in the Washington, D.C. employee benefits law firm of Groom Law Group, Chartered, where I have worked with the ACLI and many of its member companies on this and many other ERISA issues over the past several years.

ACLI is the major trade association of the life insurance industry, representing more than 400 life insurance companies. ACLI member companies hold 80% of all of the assets of U.S. life insurance companies and represent 82% of the industry's retirement plan business. Retirement plan assets managed by life insurance companies total more than $1.8 trillion, approximately one-fifth of all privately-administered pension and retirement plan assets in the United States.

ACLI thanks the subcommittee for the opportunity to testify and applauds the subcommittee's continued interest in reviewing and modernizing the Employee Retirement Income Security Act of 1974 ("ERISA"). The bipartisan review begun by Chairman Boehner and Representative Andrews last year represents the first time Congress has looked in depth at ERISA's fiduciary and prohibited transaction rules and considered whether changes to the law are needed in light of the many changes that have occurred in the retirement plan market place in the 26 years since ERISA's enactment.

ACLI strongly supports the Retirement Security Advice Act of 2001 (H.R. 2269), which was first developed and introduced last year by Chairman Boehner after the subcommittee completed a series of oversight hearings./1/ In addition, ACLI supports efforts by the subcommittee to develop legislation that would even more broadly modernize ERISA prohibited transaction rules, such as the comprehensive legislation Mr. Boehner introduced last year./2/

/1/ See "The Retirement Security Advice Act of 2000," H.R. 4747, 106th Cong. (2000).

/2/ See "The Comprehensive ERISA Modernization Act of 2000," H.R. 4748, 106th Cong. (2000).

II. The Need for Investment Advice Legislation

Over a year ago, in testimony before this subcommittee, the ACLI identified several key reasons why investment advice legislation, as well as more comprehensive legislation, is needed.

First, since ERISA was adopted, retirement plans have steadily moved from traditional defined benefit plans towards defined contribution plans (e.g., 401(k) plans) and individual retirement accounts ("IRAs"). Now, more than $5 trillion is held in defined contribution plans and IRAs where employees make investment choices and assume investment risk. During this same time period, there has been tremendous growth in the number of new investment options available to participants, including thousands of new mutual funds, new types of insurance arrangements and self-directed brokerage windows through which participants can invest in almost any debt or equity security. More and more, the retirement security of millions of Americans turns on how well they make investment decisions among a more varied and complex set of investment choices.

At the same time, ERISA's prohibited transaction rules-- as interpreted and administered by the Department of Labor ("DOL")-- have discouraged the delivery of individualized investment advice services to plan participants./3/ Under these rules, employers are concerned about providing investment advice themselves because they could assume fiduciary responsibility and liability for employee investment decisions. In contrast, the financial services firms that provide investment options and administrative services to employer plans are experienced and willing to provide advice services, but they are effectively barred from providing such services under ERISA's prohibited transaction rules.

/3/ Section 404 of ERISA sets forth broad fiduciary rules that are modeled on the common law of trusts. These provisions impose duties of loyalty, prudence and diversification on plan fiduciaries. However, section 406 of ERISA departs from the common law of trust and broadly bar certain "prohibited transactions," including transactions between employee benefit plans and "parties in interest," and conflict of interest transactions (e.g., self-dealing and kickbacks). Fiduciaries may be personally liable for violations of the fiduciary rules and may be sued for damages to make plans whole for investment losses caused by a fiduciary breach. A variety of other remedies are available for violations of sections 404 and 406, including injunctive relief and various civil and tax penalties.

Financial services firms have been largely blocked from providing specific investment advice to plan participants because the DOL has construed ERISA's prohibited transaction rules, which were adopted to prohibit self-dealing and kickbacks, to prohibit financial services firms giving specific investment recommendations on any investment options where the firm may receive an additional fee as a result of the participant's investment decision (e.g., receipt of advisory fees from the firm's proprietary mutual fund or the receipt of a 12b-1 fee from unaffiliated mutual funds).

Under DOL's approach, financial services firms must either avoid giving specific investment recommendations, or they are required to obtain individual exemptions from the DOL before advice services can be delivered. When financial services firms seek such exemptions, the DOL imposes significant "product design" conditions that regulate the types and amount of fees or require the use of independent third parties in developing asset allocation and advice programs./4/ Notably, DOL's recent exemption activity represents a departure from its approach in the 1970s and 1980s, when it issued a number of class exemptions from ERISA's conflict of interest rules for the sale of insurance products and securities that mainly conditioned relief on disclosure and consent by plan fiduciaries.

/4/ See PTE 97-12, 62 Fed. Reg. 7275 (Feb. 19, 1997) (Wells Fargo exemption requiring fee offsets); PTE 97-60, 62 Fed. Reg. 59744 (Nov. 4, 1997) (TCW requiring use of independent firm to prepare advisory services).

Because of DOL's recent approach to advisory programs, the only persons who can clearly provide specific investment advice under current law without obtaining a burdensome exemption are completely unaffiliated persons that have no established relationship with employers, plans and participants. Many of these vendors are start up companies that provide advisory services mainly over the internet. While there is clearly a role for such vendors, they alone will not close the "advice gap."

Employers and participants will benefit from being able to choose among advice services offered by both independent providers and full-service financial services firms. Financial services firms offer in-person or telephone advisory services through their networks of thousands of agents, brokers and advisers, in addition to internet services. In addition, as a practical matter, employers that sponsor plans may not make advice services available to plan participants if they are required to separately contract with someone other than the financial services firm that administers the 401(k) plan to provide advice. Larger employers generally want service providers with a nationwide capability that have an existing understanding of their plan and participants. Most employers want to use one service provider to facilitate the provision of investment options, handle recordkeeping and administrative services, as well as to coordinate the provision of investment advice and education. Under these arrangements, employers are able to access both affiliated and unaffiliated investment options through a single service provider, but they are unable to access advisory services from the same provider. Allowing the financial services firm that makes available the employer's defined contribution plan to provide advice-- rather than requiring the employer to separately arrange for such services by another firm-- will result in more employers offering advisory services to plan participants and will likely lower plan costs for such services.

There have been three additional developments since last year that further highlight the need for Congress to enact the Retirement Security Advice Act.

First, the volatility in the investment markets actually serves to reinforce the need for participants to be able to access sound investment advice. Without proper advice and education, participants may be tempted to make short-term investment decisions based solely on the recent market activity. Financial advisers can educate participants on the need to take into account the appropriate time horizons for their investment decisions, the need for diversification, the relative volatility of equity versus debt investments, and the long term expected returns on different types of categories of investments. Most importantly, advisors can help participants choose among specific investment alternatives to develop a portfolio best suited for their needs. These services are even more critical in a volatile investment environment.

Second, the sponsors of the Retirement Security Advice Act have stated that their bill is intended to close the "advice gap" created by current law. ACLI has conducted and released a new survey that clearly documents the advice gap and participant demand for investment advice./5/ The ACLI survey indicates the following:

/5/ See Investment Advice, Making Retirement Plans Work in the 21st Century, ACLI (2001).

• Nearly half of defined contribution plan and IRA investors are "not at all" (8%) or only "somewhat comfortable" (41%) making their own investment decisions;

• By a 20 point margin (55% to 35%), participants support changing the law to allow financial services companies that provided their defined contribution plan or IRA to give specific investment advice; and

• By more than a 20 point margin (58% to 35%), participants support such a change in law even if the financial services firm has a financial interest in the investment options available to the participant.

Finally, earlier this year Congress passed and the President signed the "Economic Growth and Tax Relief Reconciliation Act of 2001." The tax bill includes many favorable changes to the tax rules that govern pension plans and IRAs. These proposals, authored on a bipartisan basis by Representatives Portman and Cardin, and cosponsored by many members of this committee, significantly increase the amount of contributions that can be made to all forms of defined contribution plans and IRAs. As a result, we can expect that participants will further increase the amount of retirement savings that flow into such retirement savings plans. In addition, the tax bill reflects Congress' recognition that workplace-based retirement planning is a vital component for educating participants about their retirement./6/ Providing investment advice is an essential component of retirement planning.

/6/ The tax bill clarifies that employees will not be taxed on the fair market value of qualified retirement planning services provided by their employer. Code § 132(a)(7), (m).

III. The Retirement Security Advice Act Protects Participants

ACLI believes that the Retirement Security Advice Act is both an effective, and safe, means to address the "advice gap." The bill creates a new statutory exemption from ERISA's prohibited transaction rules for "fiduciary advisers." If the many conditions of the advice exemption are met, then "fiduciary advisers" would be able to provide specific investment recommendations and receive fees that may vary somewhat based on the investment choices made by participants. However, the legislation includes the following crucial protections that ensure that participants are protected from conflicts of interests:

• ERISA's fiduciary rules continue to apply to the provision of advice by the fiduciary-adviser. These rules require that fiduciary-advisers act prudently and solely in the interests of participants. Simply put, under these rules, it would be illegal for a fiduciary adviser to make specific investment recommendations for the purpose of increasing their (or their firm's) compensation. The adviser would be personally liable to make up any losses caused by a breach of fiduciary duty and would be subject to civil penalties.

• ERISA's fiduciary rules will continue to apply to the employer who selects the fiduciary adviser. Thus, the employer must act prudently and solely in the interest of participants in selecting and periodically monitoring the advisor. However, the bill does make clear that employers who fulfill these duties will not be liable for the specific advice given by the fiduciary adviser.

• The bill limits the provision of advice to "fiduciary advisers." Fiduciary-advisers are financial services firms that are comprehensively regulated under other federal or state securities, insurance or banking laws.

• The bill mandates the provision of significant disclosures before the fiduciary adviser may give any advice. Such disclosures will inform participants of any financial interest the fiduciary adviser may have, the nature of the adviser's affiliation (if any) with the available investment options, and any limits that may be placed on the adviser's ability to provide advice. These types of disclosure obligations, along with fiduciary duties, have worked well in regulating the conduct of advisers under federal securities laws for more than 60 years. Similar disclosures have also worked well for existing DOL class exemptions that cover the purchase of insurance contracts and affiliated mutual funds./7/

  /7/ See PTE 84-24, 49 Fed. Reg. 13208 (April 3, 1984).

• The bill keeps participants in control of their investment decisions by requiring that investment decisions be made exclusively by plan participants-- not the fiduciary adviser. The adviser may make recommendations to participants, but may not make discretionary investment decisions on behalf of participants.

• All transactions must be conducted on arm's length terms and for only reasonable compensation.

IV. Conclusion

ACLI strongly supports The Retirement Security Advice Act and we hope the bill is only the first important step by this subcommittee to modernize and update ERISA's fiduciary and prohibited transaction rules. The legislation strikes the right balance of allowing comprehensively-regulated financial services firms to provide specific investment advisory services, while at the same time carefully protecting the interests of plan participant. The result will be increased competition in the advisory services arena, which will improve such services, make them more widely available and lower costs.

Because the current bill strikes the right balance, ACLI believes that it is critical that the sponsors of the bill retain the basic framework of the bill as the bill moves through this committee and Congress. The sponsors of the bill should oppose efforts to narrow the scope of the bill to make it less flexible or to include the types of "product design" conditions and limitations that have encumbered advisory programs subject to DOL exemptions.

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