Guest Article

(From the September 2, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

DOL Proposes Rules on Investment Advice Exemptions for 401(k) Plans and IRAs

The Pension Protection Act of 2006 (PPA) established a prohibited transaction exemption allowing a fiduciary to provide investment advice to participants and beneficiaries in individual account plans (e.g., 401(k) plans) and individual retirement accounts. The statutory exemption permits the investment advice to be given either on a level-fee basis or via a computer model certified as unbiased. After determining that computer models sufficient to meet the PPA requirements do exist -- a prerequisite established by PPA -- DOL has proposed regulations on the new statutory exemption. Going a step further, DOL also proposed a class exemption allowing for individualized investment advice. 73 FR 49896 (August 22, 2008) and 73 FR 49924 (August 22, 2008).

Feasibility of Computer Model Investment Advice Programs

PPA requires that the computer model provide advice which:

In response to a Request for Information published by the DOL in December 2006 -- and a request made by the DOL of the "top 50" trustees as required by PPA -- DOL received 62 comments on the feasibility of computer model advice programs. Four commentators identified four different existing programs which, in their view, met the requirements.

With regard to the first criterion, many commentators stated that computer models are capable of utilizing relevant information. With regard to the second criterion, most commentators indicated that no program exists that can take into account the entire universe of financial instruments that may be available. DOL believes that the criterion is satisfied if the model takes into account all of the generally recognized asset classes necessary to construct a diversified portfolio. Many commentators stated that programs are capable of taking into account such asset classes. With regard to the third criterion, four commentators stated that their programs permit an account holder to change the input information (and thereby change the model's output), bypass the model's advice, and/or seek other advice. Many other commentators represented that computer models are capable of providing sufficient flexibility in obtaining investment advice.

Based on the findings, the DOL and Treasury Departments concluded that there are computer model investment advice programs that meet the PPA criteria. As a result, the PPA restriction on the availability of the statutory exemption was lifted as of August 21, 2008, the date DOL submitted the report to Congress.

Statutory Exemption for Investment Advice-Related Transactions

ERISA § 406 generally prohibits "transactions" between the plan and a fiduciary. Therefore, unless there is an exemption, a fiduciary is prohibited from rendering investment advice to a plan participant that results in the payment of additional advisory or other fees to the fiduciary or any of its affiliates. DOL Field Assistance Bulletin 2007-1. The fiduciary would also be prohibited from engaging in any other type of "transaction" in connection with the provision of investment advice -- including those transactions that fall within the broadly-constructed category of "dealing with the plan assets in his own interest or for his own account."

ERISA § 408(b)(14) provides a statutory exemption for any transaction in connection with the rendering of investment advice by a fiduciary to a participant or beneficiary which permits the participant or beneficiary to direct the investment of their individual account if the requirements of ERISA § 408(g) are met, and the transaction is:

ERISA § 408(g) allows a fiduciary to provide advice under an "eligible investment advice arrangement" -- an arrangement which either uses a computer model, or provides that any fees received (including commissions and other compensation) do not vary depending on the basis of any investment option selected. Either approach must base the investment advice on "generally accepted investment theories" that take into account the historic returns of different asset classes, and must take into account information furnished by a participant or beneficiary relating to "age, life expectancy, retirement age, risk tolerance, other assets or sources of income and investment preferences." The Proposed Regulations further require, in the case of arrangements that utilize:

The "eligible investment advice arrangement" must be expressly authorized by a plan fiduciary (or, in the case of an IRA, the IRA beneficiary) -- other than the person offering the arrangement, or any person providing designated investment options under the plan, or any affiliate of either.

The fiduciary adviser must at least annually engage an independent auditor to conduct an audit of the investment advice arrangements for compliance with the requirements of ERISA § 408(g). The auditor must, within 60 days following completion of the audit, issue a written report to the fiduciary adviser and each fiduciary who authorized use of the investment advice arrangement setting forth the findings.

The fiduciary adviser must also disclose without charge, to participants and beneficiaries before the initial provision of investment advice, written notification:

The regulations propose a model disclosure form that may be used to provide the information. Use of the form is optional, and the disclosure may be provided in written or electronic form.

The fiduciary adviser must maintain any records necessary to determine whether the requirements of ERISA § 408(g) have been met for a period of at least six years after the investment advice is provided.

The proposed regulations are to be effective 60 days after publication of the final regulations. DOL request comments on or before October 6, 2008.

Proposed Class Exemption for Individualized Investment Advice

The proposed class exemption would provide relief for individualized investment advice to individuals following the furnishing of recommendations generated by a computer model (or, in the case of an IRA with respect to which modeling is not feasible, the furnishing of certain investment educational material). Additional conditions apply, including the requirements that:

DOL request comments on the Proposed Class Exemption on or before October 6, 2008.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.