[Federal Register Volume 76, Number 206 (Tuesday, October 25, 2011)]
[Rules and Regulations]
[Pages 66136-66167]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-26261]
[[Page 66135]]
Vol. 76
Tuesday,
No. 206
October 25, 2011
Part II
Department of Labor
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Employee Benefits Security Administration
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29 CFR Part 2550
Investment Advice; Participants and Beneficiaries; Final Rule
Federal Register / Vol. 76 , No. 206 / Tuesday, October 25, 2011 /
Rules and Regulations
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB35
Investment Advice--Participants and Beneficiaries
AGENCY: Employee Benefits Security Administration, Labor.
ACTION: Final rule.
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SUMMARY: This document contains a final rule under the Employee
Retirement Income Security Act, and parallel provisions of the Internal
Revenue Code of 1986, relating to the provision of investment advice to
participants and beneficiaries in individual account plans, such as
401(k) plans, and beneficiaries of individual retirement accounts (and
certain similar plans). The final rule affects sponsors, fiduciaries,
participants and beneficiaries of participant-directed individual
account plans, as well as providers of investment and investment advice
related services to such plans.
DATES: The final rule is effective on December 27, 2011.
FOR FURTHER INFORMATION CONTACT: Fred Wong, Office of Regulations and
Interpretations, Employee Benefits Security Administration (EBSA),
(202) 693-8500. This is not a toll-free number.
SUPPLEMENTARY INFORMATION:
A. Background
Section 3(21)(A)(ii) of the Employee Retirement Income Security Act
of 1974 (ERISA) and section 4975(e)(3)(B) of the Internal Revenue Code
of 1986 (Code) include within the definition of ``fiduciary'' a person
that renders investment advice for a fee or other compensation, direct
or indirect, with respect to any moneys or other property of a plan, or
has any authority or responsibility to do so.\1\ The prohibited
transaction provisions of ERISA and the Code prohibit a fiduciary from
dealing with the assets of the plan in his own interest or for his own
account and from receiving any consideration for his own personal
account from any party dealing with such plan in connection with a
transaction involving the assets of the plan.\2\ These statutory
provisions have been interpreted as prohibiting a fiduciary from using
the authority, control or responsibility that makes it a fiduciary to
cause itself, or a party in which it has an interest that may affect
its best judgment as a fiduciary, to receive additional fees.\3\ As a
result, in the absence of a statutory or administrative exemption,
fiduciaries are prohibited from rendering investment advice to plan
participants regarding investments that result in the payment of
additional advisory and other fees to the fiduciaries or their
affiliates. Section 4975 of the Code applies similarly to the rendering
of investment advice to an individual retirement account (IRA)
beneficiary.
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\1\ See also 29 CFR 2510.3-21(c) and 26 CFR 54.4975-9(c).
\2\ ERISA section 406(b)(1) and (3) and Code section
4975(c)(1)(E) and (F).
\3\ 29 CFR 2550.408b-2(e).
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With the growth of participant-directed individual account plans,
there has been an increasing recognition of the importance of
investment advice to participants and beneficiaries in such plans. Over
the past several years, the Department of Labor (Department) has issued
various forms of guidance concerning when a person would be a fiduciary
by reason of rendering investment advice, and when such investment
advice might result in prohibited transactions.\4\ Responding to the
need to afford participants and beneficiaries greater access to
professional investment advice, Congress amended the prohibited
transaction provisions of ERISA and the Code, as part of the Pension
Protection Act of 2006 (PPA),\5\ to permit a broader array of
investment advice providers to offer their services to participants and
beneficiaries responsible for investment of assets in their individual
accounts and, accordingly, for the adequacy of their retirement
savings.
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\4\ See Interpretative Bulletin relating to participant
investment education, 29 CFR 2509.96-1 (Interpretive Bulletin 96-1);
Advisory Opinion (AO) 2005-10A (May 11, 2005); AO 2001-09A (December
14, 2001); and AO 97-15A (May 22, 1997).
\5\ Public Law 109-280, 120 Stat. 780 (Aug. 17, 2006).
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Specifically, section 601 of the PPA added a statutory prohibited
transaction exemption under sections 408(b)(14) and 408(g) of ERISA,
with parallel provisions at Code sections 4975(d)(17) and
4975(f)(8).\6\ Section 408(b)(14) sets forth the investment advice-
related transactions that will be exempt from the prohibitions of ERISA
section 406 if the requirements of section 408(g) are met. The
transactions described in section 408(b)(14) are: the provision of
investment advice to the participant or beneficiary with respect to a
security or other property available as an investment under the plan;
the acquisition, holding or sale of a security or other property
available as an investment under the plan pursuant to the investment
advice; and the direct or indirect receipt of compensation by a
fiduciary adviser or affiliate in connection with the provision of
investment advice or the acquisition, holding or sale of a security or
other property available as an investment under the plan pursuant to
the investment advice. As described more fully below, the requirements
in section 408(g) are met only if advice is provided by a fiduciary
adviser under an ``eligible investment advice arrangement.'' Section
408(g) provides for two general types of eligible arrangements: one
based on compliance with a ``fee-leveling'' requirement (imposing
limitation on fees and compensation of the fiduciary adviser); the
other, based on compliance with a ``computer model'' requirement
(requiring use of a certified computer model). Both types of
arrangements also must meet several other requirements.
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\6\ Under Reorganization Plan No. 4 of 1978 (43 FR 47713, Oct.
17, 1978), 5 U.S.C. App. 1, 92 Stat. 3790, the authority of the
Secretary of the Treasury to issue rulings under section 4975 of the
Code has been transferred, with certain exceptions not here
relevant, to the Secretary of Labor. Therefore, the references in
this notice to specific sections of ERISA should be taken as
referring also to the corresponding sections of the Code.
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On February 2, 2007, the Department issued Field Assistance
Bulletin (FAB) 2007-01 addressing certain issues presented by the new
statutory exemption. This Bulletin affirmed that the enactment of
sections 408(b)(14) and 408(g) did not invalidate or otherwise affect
prior guidance of the Department relating to investment advice and that
such guidance continues to represent the views of the Department.\7\
The Bulletin also confirmed the applicability of the principles set
forth in section 408(g)(10) [Exemption for plan sponsor and certain
other fiduciaries] \8\ to plan
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sponsors and fiduciaries who offer investment advice arrangements with
respect to which relief under the statutory exemption is not required.
Finally, the Bulletin addressed the scope of the fee-leveling
requirement under the statutory exemption.
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\7\ In this regard, the Department cited the following: August
3, 2006 Floor Statement of Senate Health, Education, Labor and
Pensions Committee Chairman Enzi (who chaired the Conference
Committee drafting legislation forming the basis of H.R. 4)
regarding investment advice to participants in which he states, ``It
was the goal and objective of the Members of the Conference to keep
this advisory opinion [AO 2001-09A, SunAmerica Advisory Opinion]
intact as well as other pre-existing advisory opinions granted by
the Department. This legislation does not alter the current or
future status of the plans and their many participants operating
under these advisory opinions. Rather, the legislation builds upon
these advisory opinions and provides alternative means for providing
investment advice which is protective of the interests of plan
participants and IRA owners.'' 152 Cong. Rec. S8,752 (daily ed. Aug.
3, 2006) (statement of Sen. Enzi).
\8\ Section 408(g)(10) addresses the responsibility and
liability of plan sponsors and other fiduciaries in the context of
investment advice provided pursuant to the statutory exemption.
Subject to certain requirements, section 408(g)(10) provides that a
plan sponsor or other person who is a plan fiduciary, other than a
fiduciary adviser, is not treated as failing to meet the fiduciary
requirements of ERISA solely by reason of the provision of
investment advice as permitted by the statutory exemption. This
provision does not exempt a plan sponsor or a plan fiduciary from
fiduciary responsibility under ERISA for the prudent selection and
periodic review of the selected fiduciary adviser.
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On January 21, 2009, the Department published in the Federal
Register final rules implementing section 408(b)(14) and 408(g) of
ERISA, and the parallel provisions in the Code.\9\ The final rules also
included an administrative class exemption, adopted pursuant to ERISA
section 408(a), granting additional prohibited transaction relief. The
effective and applicability dates of the final rules, originally set
for March 23, 2009, subsequently were delayed to allow the Department
to solicit and review comments from interested persons on legal and
policy issues raised under the final rules.\10\ Based on a
consideration of the concerns raised by commenters as to whether the
conditions of the class exemption would be adequate to mitigate
advisers' conflicts, the Department decided to withdraw the final rule.
Notice of the withdrawal of the final rule was published in the Federal
Register on November 20, 2009 (74 FR 60156).
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\9\ In connection with the development of the January 2009 final
rules, the Department published two requests for information from
the public (see 71 FR 70429 (Dec. 4, 2006) and 72 FR 70427; comments
found at http://www.dol.gov/ebsa/regs/cmt-Investmentadvice.html and
http://www.dol.gov/ebsa/regs/cmt-InvestmentadviceIRA.html);
published proposed regulations and class exemption with solicitation
of public comment (see 73 FR 49896 (Aug. 22, 2008) and 73 FR 49924;
comments found at http://www.dol.gov/ebsa/regs/cmt-investment-advice.html and http://www.dol.gov/ebsa/regs/cmt-investmentadviceexemption.html); and held public hearings on October
21, 2008 (see 73 FR 60657 (Oct. 21, 2008) and 73 FR 60720) and July
31, 2007 (see 72 FR 34043 (June 20, 2007)).
\10\ 74 FR 59092 (Nov. 17, 2009); 74 FR 23951 (May 22, 2009); 74
FR 11847 (Mar. 20, 2009). Comments can be found at: http://www.dol.gov/ebsa/regs/cmt-investmentadvicefinalrule.html.
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On March 2, 2010, the Department published in the Federal Register
new proposed regulations that, upon adoption, implement the statutory
prohibited transaction exemption under ERISA sections 408(b)(14) and
408(g), and the parallel provisions in the Code (75 FR 9360). In
response to the proposal, the Department received 74 comment
letters.\11\
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\11\ Comments can be found at: http://www.dol.gov/ebsa/regs/cmt-1210-AB35.html.
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Set forth below is an overview of the final rule and an overview of
the major comments received on the proposed rule.
B. Overview of Final Sec. 2550.408g-1 and Public Comments
1. General
In general, Sec. 2550.408g-1 tracks the requirements under section
408(g) of ERISA that must be satisfied in order for the investment
advice-related transactions described in section 408(b)(14) to be
exempt from the prohibitions of section 406. Paragraph (a) describes
the general scope of the statutory exemption and regulation. Paragraph
(b) sets forth the requirements that must be satisfied for an
arrangement to qualify as an ``eligible investment advice arrangement''
and for the exemption to apply. Paragraph (c) defines certain terms
used in the regulation. Paragraph (d) sets forth the record retention
requirement applicable to an eligible investment advice arrangement.
Paragraph (e) describes the implications of noncompliance on the
prohibited transaction relief under the statutory exemption.
The provisions in paragraph (a) of the final rule have not been
changed from the proposal. Paragraph (a)(1) describes the general scope
of the final rule, referencing the statutory exemption under sections
408(b)(14) and 408(g)(1) of ERISA, and under sections 4975(d)(17) and
4975(f)(8) of the Code, for certain transactions in connection with the
provision of investment advice, as set forth in paragraph (b) of the
final rule. It further provides that the requirements and conditions of
the final rule apply solely for the relief described in the final rule,
and that no inferences should be drawn with respect to the requirements
applicable to the provision of investment advice not addressed by the
rule.
Several comment letters raised issues with respect to the general
scope of the proposal. Although a number of commenters supported the
Department's decision with respect to the withdrawal of the class
exemption, others requested its re-proposal. The latter group argued
that increasing the availability of investment advice to plan
participants and beneficiaries requires broader prohibited transaction
relief than provided under the proposed regulation. Other commenters
argued that plan sponsors also would benefit from increased access to
investment advice, and suggested extending exemptive relief to advice
provided to plan sponsors, either through the final rule or by an
administrative class exemption. Another commenter requested that the
final rule provide relief for management of managed accounts. These
comments are beyond the scope of the proposal, which was limited to
implementation of the statutory exemption for the provision of
investment advice to plan participants and beneficiaries, and have not
been adopted by the Department.
Two commenters observed that paragraph (a)(1) indicates that the
requirements contained in the final rule should not be read as
applicable to arrangements for which prohibited transaction relief is
not necessary. They requested clarification that a plan sponsor's
selection and monitoring responsibilities do not differ for advice
provided pursuant to the regulation compared to arrangements for which
prohibited transaction relief is not necessary. In response, we note
that, as stated in FAB 2007-1, it is the Department's view that, except
for section 408(g)(10)(A)(i) to (iii), the same fiduciary duties and
responsibilities apply to the selection and monitoring of an investment
adviser regardless of whether the arrangement for investment advice
services is one to which the regulation applies. As further explained
in that Bulletin, a plan sponsor or other fiduciary that prudently
selects and monitors an investment advice provider will not be liable
for the advice furnished by such provider to the plan's participants
and beneficiaries, whether or not that advice is provided pursuant to
the statutory exemption under section 408(b)(14).
Paragraph (a)(2) provides that nothing contained in ERISA section
408(g)(1), Code section 4975(f)(8), or the final rule imposes an
obligation on a plan fiduciary or any other party to offer, provide or
otherwise make available any investment advice to a participant or
beneficiary. Paragraph (a)(3) provides that nothing contained in those
same provisions of ERISA and the Code, or the final rule invalidates or
otherwise affects prior regulations, exemptions, interpretive or other
guidance issued by the Department pertaining to the provision of
investment advice and the circumstances under which such advice may or
may not constitute a prohibited transaction under section 406 of ERISA
or section 4975 of the Code.
Several commenters suggested that, rather than merely affirming the
continued applicability of pre-PPA guidance in paragraph (a)(3),\12\
the Department should reconsider its past guidance in light of the
safeguards contained in the statutory exemption and the proposed rule.
Such an undertaking is beyond the scope of the
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current proposal, and the Department has not adopted this suggestion.
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\12\ See also Field Assistance Bulletin 2007-1 (Feb. 2, 2007).
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Other commenters requested a general clarification of how the final
rule applies in the context of IRAs. In particular, a commenter asked
if paragraph (a)(3) indicates that prior ERISA regulations are now
applicable to IRAs. Code section 4975(c), similar to ERISA section 406,
generally prohibits a plan fiduciary from rendering investment advice
that results in the payment of additional advisory and other fees to
the fiduciaries or their affiliates. A fiduciary who participates in a
prohibited transaction is subject to excise taxes under Code section
4975(a) and (b).\13\ The application of the Code section 4975
prohibited transaction provisions to IRAs pre-dates the enactment of
the PPA.\14\ The statutory exemption implemented by this rule merely
provides limited conditional relief from the application of those Code
provisions. Except for the relief afforded by the statutory exemption,
the final rule does not change the manner or extent to which Code
section 4975 applies to an IRA.\15\ Nor does the final rule make
ERISA's fiduciary responsibility provisions applicable to an IRA that
is not covered by ERISA.
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\13\ See Code section 4975(a), (b), and (e)(2)(A).
\14\ Code section 4975(e)(1)(B). Public Law 93-406 section
2003(a), 88 Stat. 971.
\15\ As indicated in footnote 6 above, pursuant to section 102
of Reorganization Plan No. 4 of 1978, the Secretary of Labor has
authority to interpret certain provisions of Code section 4975.
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Commenters also asked questions relating to the prohibited
transaction implications of making recommendations to plan participants
to roll-over plan benefits into an IRA. The Department has taken the
position that merely advising a plan participant to take an otherwise
permissible plan distribution, even when that advice is combined with a
recommendation as to how the distribution should be invested, does not
constitute ``investment advice'' within the meaning of 29 CFR 2510-
3.21(c).\16\ The Department, however, has invited public comment on the
issue as part of its review of the definition of ``fiduciary'' with
regard to persons providing investment advice to plans or plan
participants and beneficiaries under 29 CFR 2510.3-21(c).\17\ The
Department has not completed its review of those comments and,
accordingly, is not addressing the issue as part of this final rule.
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\16\ AO 2005-23A (Dec. 7, 2005). This opinion further states
that where someone who is already a plan fiduciary responds to
participant questions concerning the advisability of taking a
distribution or the investment of amounts withdrawn from the plan,
that fiduciary is exercising discretionary authority respecting
management of the plan and must act prudently and solely in the
interest of the participant.
\17\ 75 FR 65263 (Oct. 22, 2010).
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2. Statutory Exemption
a. General
Paragraph (b) of the final rule describes the requirements that
must be satisfied in order for the investment advice-related
transactions described in section 408(b)(14) to be exempt from the
prohibitions of section 406. These requirements generally track the
requirements in section 408(g)(1) of ERISA.
Paragraph (b)(1) of the final rule sets forth the general scope of
the statutory exemption and regulation as providing relief from the
prohibitions of section 406 of ERISA for transactions described in
section 408(b)(14) of ERISA in connection with the provision of
investment advice to a participant or a beneficiary if the investment
advice is provided by a fiduciary adviser under an ``eligible
investment advice arrangement.'' The transactions described in section
408(b)(14) include the provision of investment advice to a participant
or beneficiary with respect to a security or other property available
as an investment under the plan; the acquisition, holding or sale of a
security or other property available as an investment under the plan
pursuant to the advice; and the direct or indirect receipt of fees or
other compensation by the fiduciary adviser or an affiliate in
connection with the provision of the advice or in connection with the
acquisition, holding or sale of the security or other property.
Paragraph (b)(1) also notes that the Code contains parallel provisions
at section 4975(d)(17) and (f)(8).
A commenter asked whether relief would be provided for extensions
of credit intrinsic to investments made pursuant to investment advice
rendered. It is the view of the Department that transactions in
connection with the provision of investment advice described in section
3(21)(A)(ii) of ERISA include, for purposes of the statutory exemption,
otherwise permissible routine transactions necessary for the efficient
execution and settlement of trades of securities, such as extensions of
short term credit in connection with settlements.
Commenters also requested clarification as to whether advice to a
participant or beneficiary concerning the selection of an investment
manager to manage some or all of the participant's or beneficiary's
plan assets constitutes the provision of investment advice within the
meaning of section 3(21)(A)(ii) of ERISA for purposes of the statutory
exemption. As previously stated in the context of adopting the 2009
final rule, the Department has long held the view that individualized
recommendations of particular investment managers to plan fiduciaries
constitutes the provision of investment advice within the meaning of
section 3(21)(A)(ii) in the same manner as recommendations of
particular securities or other property. The fiduciary nature of such
advice does not change merely because the advice is being given to a
plan participant or beneficiary.\18\ The Department has reaffirmed this
position in connection with proposed amendments to regulations at 29
CFR 2510.3-21(c).\19\
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\18\ 74 FR 3822, 3824 (Jan. 21, 2009). See also AO 84-04A (Jan.
4, 1984); AO 84-03A (Jan. 4, 1984); 29 CFR 2509.96-1(c).
\19\ See footnote 17, above.
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Paragraph (b)(2) provides that, for purposes of section 408(g)(1)
of ERISA and section 4975(f)(8) of the Code, an ``eligible investment
advice arrangement'' is an arrangement that meets either the
requirements of paragraph (b)(3) [describing investment advice
arrangements that use fee-leveling] or paragraph (b)(4) [describing
investment advice arrangements that use computer modeling], or both.
b. Arrangements Using Fee-Leveling
With respect to arrangements that use fee-leveling, paragraph
(b)(3)(i)(A) requires that any investment advice must be based on
generally accepted investment theories that take into account historic
returns of different asset classes over defined periods of time, but
also notes that generally accepted investment theories that take into
account additional considerations are not precluded. Paragraph
(b)(3)(i)(B) requires that investment advice must take into account
investment management and other fees and expenses attendant to the
recommended investments. These provisions have not been changed from
the proposal.
Paragraph (b)(3)(i)(C) of the final rule requires that investment
advice provided under a fee-leveling arrangement must take into
account, to the extent furnished, information relating to age, time
horizons (e.g., life expectancy, retirement age), risk tolerance,
current investments in designated investment options, other assets or
sources of income, and investment preferences of the participant or
beneficiary. Despite a request for re-consideration by commenters,
paragraph (b)(3)(i)(C) requires that a fiduciary adviser must request
such information. These
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commenters noted that ERISA section 408(g)(3) does not contain a
mandatory request for information, and that the Department similarly
should avoid such a mandate. The Department believes that this
information is sufficiently important to the provision of useful
investment advice that fiduciary advisers should be required to make a
request for the information. Accordingly, this requirement is retained
in both the fee-leveling and computer modeling provisions of the final
rule. We note that, as also reflected in paragraph (b)(3)(i)(C) of the
final rule, investment advice need not take into account information
requested, but not furnished by a participant or beneficiary, and a
fiduciary adviser is not precluded from requesting and taking into
account additional information that a plan or participant or
beneficiary may provide. Furthermore, the Department does not believe
that this provision, or paragraph (b)(4)(i)(D) applicable to
arrangements using computer models, would preclude a fiduciary adviser
or computer model, when making an information request, from also
providing a participant or beneficiary with an opportunity to direct
the use of information previously provided.
Paragraphs (b)(3)(i)(D) of the final rule sets forth the
limitations on fees and compensation applicable to fee-leveling
arrangements. As proposed, paragraph (b)(3)(i)(D) provided that no
fiduciary adviser (including any employee, agent, or registered
representative) that provides investment advice receives from any party
(including an affiliate of the fiduciary adviser), directly or
indirectly, any fee or other compensation (including commissions,
salary, bonuses, awards, promotions, or other things of value) that is
based in whole or in part on a participant's or beneficiary's selection
of an investment option. Some commenters suggested that the fee and
compensation limitation be expanded to include the affiliates of a
fiduciary adviser. The Department has not adopted this suggestion. In
FAB 2007-1, the Department concluded that the requirement in ERISA
section 408(g)(2)(A)(i) that fees not vary depending on the basis of
any investment option selected applies only to a fiduciary adviser, and
does not extend to affiliates of the fiduciary adviser unless the
affiliate also is a provider of investment advice. In reaching this
conclusion, the Department explained that, consistent with its previous
guidance, if the fees and compensation received by an affiliate of a
fiduciary that provides investment advice do not vary or are offset
against those received by the fiduciary for the provision of investment
advice, no prohibited transaction will result solely by reason of
providing investment advice, and prohibited transaction relief, such as
provided under sections 408(b)(14) and 408(g), is not necessary.\20\
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\20\ See AO 97-15A and AO 2005-10A.
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Several commenters suggested that the Department revise the
language in paragraph (b)(3)(i)(D) that refers to fees or compensation
that is ``based in whole or in part'' on a participant's investment
selection to conform to the statutory provision, and make clear that
the regulation only proscribes fees or compensation that vary based on
investment selections. As an example, a commenter explained that if
commissions paid with respect to each plan investment option are the
same, the commission could nonetheless be considered ``based on'' an
investment selection because it is paid only if an investment is made,
and therefore would appear to violate the proposal. Such a result, it
is argued, is inconsistent with the section 408(g)(2)(A)(i), which only
requires that ``any fees (including any commission or other
compensation) received by the fiduciary adviser * * * do not vary
depending on the basis of any investment option selected.'' (Emphasis
added) Another commenter cautioned that the proposal could be
misinterpreted as proscribing only those payments that a payor intends
to act as an incentive, whereas the statutory provision appears to
address receipt of any varying payment that has the effect of creating
an incentive, without regard to the payor's intent.\21\ This commenter
also recommended that the proposal should be revised to conform to the
statutory language.
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\21\ The commenter focused on the Department's preamble
explanation that, even though an affiliate of a fiduciary adviser
would be permitted to receive fees that vary depending on investment
options selected, any provision of financial or economic incentives
by an affiliate (or any other party) to a fiduciary adviser or
person employed by such fiduciary adviser to favor certain
investments would be impermissible under the proposal. 75 FR 9361
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The Department agrees with the observations of the commenters and,
accordingly, has revised the provision in response to these comments.
Paragraph (b)(3)(i)(D) of the final rule requires that no fiduciary
adviser (including any employee, agent, or registered representative)
that provides investment advice receives from any party (including an
affiliate of the fiduciary adviser), directly or indirectly, any fee or
other compensation (including commissions, salary, bonuses, awards,
promotions, or other things of value) that varies depending on the
basis of a participant's or beneficiary's selection of a particular
investment option. Consistent with the statute, this provision
proscribes the receipt of fees or compensation that vary based on
investment options selected, and therefore could have the effect of
creating an incentive for a fiduciary adviser, or any individual
employed by the adviser, to favor certain investments.
A commenter expressed the view that by encompassing bonuses,
awards, promotions, or other things of value, the fee-leveling
requirement may be unnecessarily broad. Some commenters asked whether
particular compensation arrangements or structures described in their
comment letters would meet the fee-leveling requirement. Others
similarly sought confirmation that bonuses, where it can be established
that plan and IRA components are excluded from, or constitute a
negligible portion of, the calculation, would not violate the fee-
leveling requirement. The Department intends the fee-leveling
requirement to be broadly applied in order to ensure the objectivity of
the investment advice recommendations to plan participants and
beneficiaries is not compromised by the advice provider's own financial
interest in the outcome. For purposes of applying the provision, the
Department would consider things of value to include trips, gifts and
other things that, while having a value, are not given in the form of
cash. Accordingly, almost every form of remuneration that takes into
account the investments selected by participants and beneficiaries
would likely violate the fee-leveling requirement of the final rule. On
the other hand, a compensation or bonus arrangement that is based on
the overall profitability of an organization may be permissible if the
individual account plan and IRA investment advice and investment option
components are excluded from, or constituted a negligible portion of,
the calculation of the organization's profitability. The Department
believes, however, that whether any particular salary, bonus, awards,
promotions or commissions program meets or fails the fee-leveling
requirement ultimately depends on the details of the program. In this
regard, the Department notes that, under paragraph (b)(6), the details
of such programs will be the subject of both a review and a report by
an independent auditor as a condition for relief under the statutory
exemption.
In addition to the foregoing, under paragraph (b)(3)(ii), fiduciary
advisers utilizing investment advice
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arrangements that employ fee-leveling must comply with the requirements
of paragraphs (b)(5) [authorization by plan fiduciary], (b)(6)
[audits], (b)(7) [disclosure to participants], (b)(8) [disclosure to
authorizing fiduciary], (b)(9) [miscellaneous], and (d) [maintenance of
records] of the final rule, each of which is discussed in more detail
below.
c. Arrangements Using Computer Models
Paragraph (b)(4) addresses the requirements applicable to
investment advice arrangements that rely on use of computer models
under the statutory exemption. To qualify as an eligible investment
advice arrangement, the only investment advice provided under the
arrangement must be advice generated by a computer model described in
paragraph (b)(4)(i) [computer model design and operation] and (ii)
[computer model certification], and the arrangement must meet the
requirements of paragraphs (b)(5) through (9) and paragraph (d), each
of which is discussed in more detail below.
1. Computer Model Design and Operation
In general, the computer model design and operation provisions in
the proposal were based on section 408(g)(3)(B)(i)-(v) of ERISA. They
also reflected comments received during development of the January 2009
final rule. However, the proposal also included a new provision, at
paragraph (b)(4)(i)(E)(3), requiring that a computer model must be
designed and operated to avoid investment recommendations that
inappropriately distinguish among investment options within a single
asset class on the basis of a factor that cannot confidently be
expected to persist in the future. The Department added this provision
to enhance the rule's protections against the potential that the
adviser's conflicts might taint advice given under the exemption. To
further explore the merits of enhancing the rule's protections by
providing more specific computer model standards, the Department
solicited comment on a number of questions involving computer models.
These questions related to matters such as the identification and
application of, and practices consistent with, generally accepted
investment theories; use of historical data (such as past performance)
of asset classes and plan investments; and criteria appropriate for
consideration in developing asset allocation recommendations consisting
of plan investments.
As in the proposal, paragraph (b)(4)(i)(A) of the final rule
relates to the application of generally accepted investment theories
that take into account the historic risks and returns of different
asset classes over defined periods of time. In response to the
Department's solicitation, commenters indicated that generally accepted
investment theories is a term defined by wide usage and acceptance by
investment experts and academics, and is subject to change over time.
Most did not believe, however, that the Department should specifically
define or identify generally accepted investment theories, or prescribe
particular practices or computer model parameters. These commenters
explained that economic and investment theories and practices
continuously evolve over time in response to changes and developments
in academic and expert thinking, technology, and financial markets.
Commenters cautioned that defining generally accepted theories and
practices through the final rule would reflect a determination made at
a particular point in time, and that such a determination might limit
the ability of advisers to select and apply investment theories and
methodologies they believe to be appropriate, and cause them to apply
theories and methodologies that they otherwise might determine to be
outdated. They also suggested that establishing a specific standard
might inhibit innovation in participant-oriented investment advice.
Commenters further noted that the proposal's computer model provisions,
without modification, would be sufficient to protect against use of
specious or highly unorthodox methods, or inappropriate consideration
of factors such as recent performance of plan investment options. These
commenters therefore suggested that specifying theories and practices
is not necessary to protect participants, and furthermore may impede
the development of advice that is in their best interests.
Other commenters suggested that more specific standards might be
helpful. One commenter stated that lack of guidance on what constitutes
a generally accepted investment theory may present difficulties in
performing the rule's required computer model certifications. The
commenter recommended that the Department revise the rule to include a
process for determining whether a theory is generally accepted, which
could include submission to a panel of experts for determination and
publication of an acceptable list of theories. Another commenter
suggested that the final rule contain non-exclusive ``safe harbor''
computer model parameters. Another commenter requested clarification
that a computer model must apply generally accepted investment theories
that take into account the other considerations described in the
regulation's computer model provisions (e.g., information about a
participants age and time horizon).
Virtually all commenters who addressed this issue indicated that
use of historical performance data is required by generally accepted
investment theories, but only in ways that recognize statistical
uncertainty. Most noted that defining ``historical'' differently can
have a tremendous impact on the resulting data and investment
recommendations, and generally agreed that long-term performance
information is preferable to short-term performance information. Some
opined that historical performance data must reflect at least one
market or economic cycle, but provided different timeframes (e.g., at
least 5, 10, or 20 years) that they believe would meet this standard.
Some also suggested that use of historical performance data should be
limited to estimating future performance for an entire asset class,
rather than as a predictor for individual investments within an asset
class.
After careful consideration of all the comments on the issue, the
Department does not believe it has a sufficient basis for determining
appropriate changes to the generally accepted investment theory
standard. While several commenters described theories and practices
they believe to be generally accepted, there did not appear to be any
consensus among them, with the exception of modern portfolio
theory,\22\ which the Department believes is already reflected in the
rule's reference to investment theories that take into account the
historic returns of different asset classes over defined periods of
time. Moreover, the Department is concerned that attempting to provide
further clarification or additional specificity in this area may have
potentially significant unintended consequences--such as limiting
advisers' ability to select, apply or make further innovations in
participant-oriented investment advice--that could potentially lower
the quality of
[[Page 66141]]
investment advice received by participants and reduce the economic
benefit of the statutory exemption. The Department also is persuaded
that, without additional specificity, the final rule's computer model
requirements are sufficient to safeguard participants from
inappropriate application of investment theories. As the party seeking
prohibited transaction relief under the exemption, the fiduciary
adviser has the burden of demonstrating satisfaction of all applicable
requirements of the exemption. A fiduciary adviser relying on use of
computer models therefore must be able to demonstrate that the computer
model is designed and operated to apply generally-accepted investment
theories. Furthermore, as with the other computer model requirements in
paragraph (b)(4)(i), application of generally-accepted investment
theories is subject to certification by an eligible investment expert
under paragraph (b)(4)(ii). This provides significant additional
procedural and substantive safeguards, as the expert must be
independent of the fiduciary adviser as described in paragraph
(b)(4)(ii), and must following its evaluation of a computer model
prepare a written certification report. Paragraph (d) of the final
rule, in turn, requires the fiduciary adviser to retain for a period of
no less than 6 years any records necessary for determining whether the
applicable requirements of the regulation have been met.
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\22\ This is consistent with a survey of literature on generally
accepted investment theories prepared for the Department. See
Deloitte Financial Advisory Services LLP, Generally Accepted
Investment Theories (July 11, 2007) (unpublished, on file with the
Department of Labor).
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Accordingly, paragraph (b)(4)(i)(A) of the final rule has not been
changed from the proposal. This provision requires that a computer
model must be designed and operated to apply generally accepted
investment theories that take into account the historic risks and
returns of different asset classes over defined periods of time, but
also makes clear that the provision does not preclude a computer model
from applying generally accepted investment theories that take into
account additional considerations.
Paragraph (b)(4)(i)(B) of the final rule requires that a computer
model must take into account investment management and other fees and
expenses attendant to the recommended investments. No substantive
comments were received on this provision, and it is being adopted
unchanged from the proposal.
Paragraph (b)(4)(i)(C) of the final rule, as described below,
reflects the requirement that was contained in paragraph
(b)(4)(i)(E)(3) of the proposal.
Paragraph (b)(4)(i)(D) of the final rule, as with paragraph
(b)(4)(i)(C) of the proposal, requires a computer model to request from
a participant or beneficiary and, to the extent furnished, utilize
information relating to age, time horizons, risk tolerance, current
investments in designated investment options, other assets or sources
of income, and investment preferences. The provision further makes
clear, however, that a computer model is not precluded from requesting,
and utilizing, other information from a participant or beneficiary. As
discussed above in the description of paragraph (b)(3)(i)(C)
(applicable to arrangements that use fee-leveling), the Department has
not adopted commenter requests to remove the regulation's mandatory
request for information from participants and beneficiaries. A few
commenters also suggested that the Department revise the regulation to
provide additional factors that must be considered in computer models,
such as participant contribution rates and liquidity needs. Although
paragraph (b)(4)(i)(D) has not been modified to reflect these factors,
the Department notes that there is nothing in the final rule that
expressly precludes a computer model from requesting and taking into
account additional factors to the extent the model otherwise complies
with the requirements of the regulation.
Paragraph (b)(4)(i)(D) of the proposal requires that a computer
model must be designed and operated to utilize appropriate objective
criteria to provide asset allocation portfolios comprised of investment
options available under the plan. Paragraph (b)(4)(i)(E) of the
proposal further requires that a computer model be designed and
operated to avoid investment recommendations that inappropriately favor
investment options offered by the fiduciary adviser or certain other
persons, over other investment options, if any, available under the
plan (paragraph (b)(4)(i)(E)(1)); inappropriately favor investment
options that may generate greater income for the fiduciary adviser or
certain other persons (paragraph (b)(4)(i)(E)(2)); or inappropriately
distinguish among investment options within a single asset class on the
basis of a factor that cannot confidently be expected to persist in the
future (paragraph (b)(4)(i)(E)(3)). With respect to paragraph
(b)(4)(i)(E)(3), the Department explained that while some differences
between investment options within a single asset class, such as
differences in fees and expenses or management style, are likely to
persist in the future and therefore to constitute appropriate criteria
for asset allocation, other differences, such as differences in
historical performance, are less likely to persist and therefore less
likely to constitute appropriate criteria for asset allocation; asset
classes, in contrast, can more often be distinguished from one another
on the basis of differences in their historical risk and return
characteristics.
The Department did not receive any substantive comments with
respect to paragraphs (b)(4)(i)(D), (b)(4)(i)(E)(1) and (2), and
therefore is adopting these provisions as proposed, now at paragraphs
(b)(4)(i)(E), (b)(4)(i)(F)(1) and (2) of the final rule. A number of
commenters requested that the Department consider removing paragraph
(b)(4)(i)(E)(3) of the proposal. Some opined that the test contained in
that provision--which applies on an asset-class by asset-class basis--
lacks sufficient clarity because it fails to define the essential term
``asset class.'' A commenter further noted that a rules-based
definition of asset class, and the necessary confidence of future
persistence, likely would be too vague or too restrictive. Some
commenters also requested removal of this provision unless the
Department clarifies that it would be acceptable for a computer model
to take into account historical performance data. According to these
commenters, the proposal's discussion of paragraph (b)(4)(i)(E)(3) and
related computer model questions has been construed as strictly
prohibiting, or strongly cautioning against, any consideration of
historical performance data, even if considered in conjunction with
other information. These commenters opined that a complete disregard of
historical performance data would be inconsistent with generally
accepted investment theories, as discussed above. Furthermore, some
cautioned that, by limiting consideration to only those factors that
can confidently be expected to persist in the future, a computer model
might be limited to distinguishing between investment options solely on
the basis of fees and expenses. A commenter noted that, other than
fees, it could not identify any other factor with the necessary
likelihood of persistence it believed would be required under the
proposal. Although commenters generally agreed that fees are an
important consideration, most recognized they should not be the only
factor taken into account.
Several commenters indicated that, while the rule is limited to
implementation of the statutory exemption for investment advice, any
views the Department expresses with respect to investment theories and
practices might be read as applying more generally to any fiduciary
decision
[[Page 66142]]
relating to investments. Thus, a number of commenters expressed concern
that the proposal, with its focus on historical performance data,
superior past performance and fees, appeared to suggest that it would
be impermissible under any circumstances for a plan fiduciary to pursue
an active management style, or that a plan fiduciary would bear a very
high burden of justification. Commenters also stated that the
Department's proposal appeared to demonstrate a clear bias in favor of
passive investment styles over active styles, which they believe to be
premature because it is the subject of ongoing debate among investment
experts.
Other commenters, however, questioned the utility of historical
performance data beyond estimating future performance of an entire
asset class. They further noted that, because the regulation permits a
fiduciary adviser to provide investment recommendations to plan
participants when the adviser has an interest in the investment options
being recommended, there is the potential that the computer model might
be designed to favor certain options by giving undue weight to
historical performance data. They therefore stressed the importance of
scrutinizing the use of historical performance data and supported the
inclusion of paragraph (b)(4)(i)(E)(3) of the proposal.
Paragraph (b)(4)(i)(E)(3) of the proposal incorporated the
generally-recognized premise that an investment option's historical
performance on its own is not an adequate predictor of such investment
option's future performance. The provision was not intended to prohibit
a computer model from any consideration of an investment option's
historical performance, as some commenters interpreted. Rather, as some
commenters recognized, the provision is intended to ensure that in
evaluating investment options for asset allocation, it would be
appropriate and consistent with generally accepted investment theories
for a computer model to take into account multiple factors, including
historical performance, attaching weights to those factors based on
surrounding facts and circumstances. As with the consideration of fees
and expenses attendant to investment options, commenters generally
recognized the importance of ensuring that historical performance of
options is not given inappropriate weight. The Department is not
persuaded by the comments received that the provision should be
eliminated, however, to avoid further misinterpretation of the
provision, the requirement has been clarified and moved to paragraph
(b)(4)(i)(C) of the final rule. This provision requires that a computer
model must be designed and operated to appropriately weight the factors
used in estimating future returns of investment options.
Paragraph (b)(4)(i)(G)(1) of the final rule, like paragraph
(b)(4)(i)(F)(1) of the proposal, requires a computer model to take into
account all ``designated investment options'' available under the plan
without giving inappropriate weight to any investment option. The term
``designated investment option'' is defined in paragraph (c)(1) of the
final rule to mean any investment option designated by the plan into
which participants and beneficiaries may direct the investment of
assets held in, or contributed to, their individual accounts. The term
``designated investment option'' does not include ``brokerage
windows,'' ``self-directed brokerage accounts,'' or similar plan
arrangements that enable participants and beneficiaries to select
investments beyond those designated by the plan.
As with paragraph (b)(4)(i)(F)(2) of the proposal, paragraph
(b)(4)(i)(G)(2) of the final rule provides that a computer model will
not be treated as failing to meet paragraph (b)(4)(i)(G)(1) merely
because it does not make recommendations relating to the acquisition,
holding or sale of certain types of investment options. Under the
proposal, this exception applied to: qualifying employer securities; an
investment that allocates the invested assets of a participant or
beneficiary to achieve varying degrees of long-term appreciation and
capital preservation through equity and fixed income exposures, based
on a defined time horizon or level of risk of the participant or
beneficiary; and an annuity option with respect to which a participant
or beneficiary may allocate assets toward the purchase of a stream of
retirement income payments guaranteed by an insurance company.
Several commenters suggested removal of one or more of these
exceptions. Commenters noted that requiring computer models to be
capable of providing recommendations with respect to employer
securities could help participants avoid risks associated with
overconcentrated investments in equity securities of a single company.
As to asset allocation funds (e.g., lifecycle, or target date, funds),
commenters noted that, if a computer model does not include
recommendations on these popular investments, then interested
participants would need to conduct their own research beyond the
general explanation required under the proposal.\23\ With respect to
in-plan annuity options, several commenters noted that these newly-
developing options can help participants address longevity risk and
improve retirement security, and that permitting their exclusion from
computer model advice could result in low utilization by participants.
A commenter also expressed confidence that, in the time since the
Department's 2009 final rule, computer modeling technology has become
sufficiently sophisticated to take in-plan annuity options into
account.
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\23\ Under paragraph (b)(4)(i)(F)(2)(ii) of the proposal, the
limitation for these types of funds was subject to the condition
that the participant, contemporaneous with the provision of the
computer-generated advice, would be furnished with a general
description of the fund and how they operate.
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The Department has decided to remove qualifying employer securities
and asset allocations funds from the list of excepted options in
paragraph (b)(4)(i)(G)(2). The Department believes that it is feasible
to develop a computer model capable of addressing investments in
qualifying employer securities, and that plan participants may
significantly benefit from this advice. The Department also believes
that participants who seek investment advice as they manage their plan
investments would benefit from advice that takes into account asset
allocation funds, if available under the plan. Based on recent
experience in examining target date funds and similar investments, the
Department believes it is feasible to design computer models with this
capability.\24\
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\24\ In 2009, the Department and the U.S. Securities and
Exchange Commission (SEC) held a joint public hearing to examine
issues related to the design and operation of target date funds and
similar investments. See http://www.dol.gov/ebsa/regs/cmt-targetdatefundshearing.html. In 2010, the agencies jointly provided
an Investor Bulletin to help investors and plan participants better
understand the operations and risks of target date fund investments.
See http://www.dol.gov/ebsa/pdf/TDFinvestorbulletin.pdf. The
Department is in the process of developing regulations to address
disclosures related to target date funds, 75 FR 73987 (Nov. 30,
2010), and also is currently developing guidance to assist plan
sponsors in the selection and monitoring of target date funds for
their plans.
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The Department, however, is less certain that computer models are
able to give adequate consideration to in-plan annuity products, which
permit a participant to allocate a portion of the assets in his or her
plan account towards the purchase of an annuitized retirement benefit.
In the absence of a better understanding of the computer modeling
issues raised by in-plan annuities, the Department is hesitant to
mandate their inclusion in a computer
[[Page 66143]]
model. The Department therefore is retaining the exception for in-plan
annuity options. Thus, paragraph (b)(4)(i)(G)(2)(i) of the final rule
provides that a computer model will not fail to satisfy paragraph
(b)(4)(i)(G)(1) merely because it does not make recommendations
relating to the acquisition, holding, or sale of an annuity option with
respect to which a participant or beneficiary may allocate assets
toward the purchase of a stream of retirement income payments
guaranteed by an insurance company, provided that, contemporaneous with
the provision of investment advice generated by the computer model, the
participant or beneficiary is also furnished a general description of
such options and how they operate. The Department notes, however, that
even though paragraph (b)(4)(i)(G)(2)(i) permits a computer model to
not make recommendations to allocate amounts to an in-plan annuity,
amounts that a participant or beneficiary have already allocated to
such an annuity must be taken into account by the computer model in
developing the recommendation with respect to the investment of the
participant's remaining available assets. The Department further notes
that, while not mandated, there is nothing in the regulation that
precludes a computer model from being designed to make recommendations
to allocate amounts to an in-plan annuity, subject to the other
conditions of the regulation being satisfied.
Also, the Department has added a new provision to reflect the
interaction between paragraph (b)(4)(i)(G)(1) and paragraph
(b)(4)(i)(C), which requires a computer model to request and, to the
extent furnished, take into account a participant's investment
preferences. This new provision, paragraph (b)(4)(i)(G)(2)(ii) of the
final rule, provides that a computer model will not fail to satisfy
paragraph (b)(4)(i)(G)(1) merely because it does not provide a
recommendation with respect to an investment option that a participant
or beneficiary requests to be excluded from consideration in such
recommendations.
A commenter requested clarification as to whether an IRA with an
unlimited universe of investment options would be treated similar to a
brokerage window or self-directed brokerage account for purposes of
this provision. Another commenter indicated that some IRAs permit
beneficiaries to make investments in a limited universe of options,
while also permitting them to hold other investments that are not
offered by the IRA, and asked if paragraph (b)(4)(i)(G)(1) would be
violated if a computer model provides ``buy'' ``hold'' and ``sell''
recommendations with respect to the limited universe of options, while
accommodating ``hold'' and ``sell'' recommendations for the investments
not available through the IRA. While the Department believes that
computer models should, with few exceptions, be required to model all
investment options available under a plan or through an IRA, the
Department does not believe that it is reasonable to expect that all
computer models be capable of modeling the universe of investment
options, rather than just those investment alternatives designated as
available investments through the IRA. Accordingly, it is the view of
the Department that a computer model would not fail to meet the
requirements of paragraph (b)(4)(i)(G)(1) merely because it limits buy
recommendations only to those investment options that can be bought
through the plan or IRA, even if the model is capable of modeling hold
and sell recommendations with respect to investments not available
through the plan or IRA, provided, of course, that the plan participant
or beneficiary or IRA beneficiary is fully informed of the model's
limitations in advance of the recommendations, thereby enabling the
recipient of advice to assess the usefulness of the recommendations.
2. Computer Model Certification
Paragraph (b)(4)(ii) of the final rule, like the proposal, requires
that, prior to utilization of the computer model, the fiduciary adviser
must obtain a written certification that the computer model meets the
requirements of paragraph (b)(4)(i), discussed above. If the model is
subsequently modified in a manner that may affect its ability to meet
the requirements of paragraph (b)(4)(i), the fiduciary adviser, prior
to utilization of the modified model, must obtain a new certification.
The required certification must be made by an ``eligible investment
expert,'' within the meaning of paragraph (b)(4)(iii), and must be made
in accordance with the requirements of paragraph (b)(4)(iv).
Paragraph (b)(4)(iii) of the final rule, like the proposal, defines
an ``eligible investment expert'' to mean a person that, through
employees or otherwise, has the appropriate technical training or
experience and proficiency to analyze, determine and certify, in a
manner consistent with paragraph (b)(4)(iv), whether a computer model
meets the requirements of paragraph (b)(4)(i). Consistent with section
408(g)(3)(C)(iii) of ERISA, paragraph (b)(4)(iii) further limits this
definition by excluding certain parties that would not have sufficient
independence from an arrangement to certify a computer model for
compliance with the regulation. The proposal provided that the term
``eligible investment expert'' does not include any person that has any
material affiliation or material contractual relationship with the
fiduciary adviser, with a person with a material affiliation or
material contractual relationship with the fiduciary adviser, or with
any employee, agent, or registered representative of the foregoing.
Several commenters asked for additional guidance on the credentials
necessary to serve as an ``eligible investment expert.'' The Department
previously attempted to define with greater specificity the
qualifications of the eligible investment expert. It received public
comments on this issue in response to a specific request for
information published in 2006 and to similar proposed rules published
in 2008.\25\ At that time, it concluded that it could not define a
specific set of academic or other credentials for an eligible
investment expert. The Department continues to believe it would be very
difficult to do so, and the comments received with respect to this most
recent proposal did not provide significant additional information for
consideration. As a result, no changes have been made to this aspect of
the final rule. The Department notes, however, that as provided in
paragraph (b)(4)(v) of the final rule, the fiduciary adviser's
selection of the eligible investment expert is a fiduciary act governed
by section 404(a)(1) of ERISA. Therefore, a fiduciary adviser must act
prudently in its selection. Moreover, as the party seeking prohibited
transaction relief under the exemption, the fiduciary adviser has the
burden of demonstrating that all applicable requirements of the
exemption are satisfied with respect to its arrangement.
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\25\ See footnote 9, above.
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Commenters raised general questions as to whether the provision of
certain types of services for a fiduciary adviser would disqualify a
person from acting as the ``eligible investment expert'' required under
paragraph (b)(4) or as the independent auditor required under paragraph
(b)(6).\26\ With respect to the eligible investment expert, the
Department believes that the 10% gross revenue test in the definition
of the term ``material contractual relationship,''
[[Page 66144]]
which contemplates that there may be instances in which a person might
be performing other services for a fiduciary adviser or affiliates,
generally is sufficient to minimize any influence on the part of the
fiduciary adviser by virtue of service relationships that might
compromise the independence of the person in performing the
certification under the regulation. However, the Department does not
believe that a person who develops a computer model should be
considered sufficiently independent to conduct a certification of the
same model.\27\ The exclusionary language of paragraph (b)(4)(iii) of
the final rule has been modified accordingly, and provides that the
term ``eligible investment expert'' does not include any person that:
Has any material affiliation or material contractual relationship with
the fiduciary adviser, with a person with a material affiliation or
material contractual relationship with the fiduciary adviser, or with
any employee, agent, or registered representative of the foregoing; or
develops the computer model utilized by the fiduciary adviser to
satisfy paragraph (b)(4).
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\26\ The Department's response as it relates to the independent
auditor is contained in the discussion of the audit provisions,
below.
\27\ For example, a person who develops a computer model used
under the exemption generally is treated as a fiduciary adviser
under paragraph (c)(2)(ii) of the final rule. However, the fiduciary
election described in Sec. 2550.408g-2 permits another person to be
treated as fiduciary adviser.
---------------------------------------------------------------------------
One commenter asked whether the eligible investment expert must be
bonded for purposes of section 412 of ERISA. In the view of the
Department, an eligible investment expert, in performing the computer
model certification described in the final rule, would neither be
acting as a fiduciary under ERISA, nor be ``handling'' plan assets such
that the bonding requirements would be applicable to the eligible
investment expert.
Paragraph (b)(4)(iv) of the final rule provides that a
certification by an eligible investment expert shall be in writing and
contain the following: An identification of the methodology or
methodologies applied in determining whether the computer model meets
the requirements of paragraph (b)(4)(i) of the final rule; an
explanation of how the applied methodology or methodologies
demonstrated that the computer model met the requirements of paragraph
(b)(4)(i); and a description of any limitations that were imposed by
any person on the eligible investment expert's selection or application
of methodologies for determining whether the computer model meets the
requirements of paragraph (b)(4)(i). In addition, the certification is
required to contain a representation that the methodology or
methodologies were applied by a person or persons with the educational
background, technical training or experience necessary to analyze and
determine whether the computer model meets the requirements of
paragraph (b)(4)(i); and a statement certifying that the eligible
investment expert has determined that the computer model meets the
requirements of paragraph (b)(4)(i). Finally the certification must be
signed by the eligible investment expert. The Department received no
comments on this provision and, accordingly, has adopted the provision
as proposed.
Paragraph (b)(4)(v) of the final rule provides that the selection
of an eligible investment expert as required by the regulation is a
fiduciary act governed by section 404(a)(1) of ERISA. A commenter
recommended that the eligible investment expert should be treated as a
fiduciary under ERISA. The Department does not believe it would be
appropriate, as part of this final rule, without further notice and
comment to adopt such a potentially significant change. Accordingly,
the Department has not adopted this recommendation.
d. Authorization by a Plan Fiduciary
Paragraph (b)(5)(i) of the final rule requires that, except as
provided in paragraph (b)(5)(ii), the arrangement pursuant to which
investment advice is provided to participants and beneficiaries 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;
any person providing designated investment options under the plan; or
any affiliate of either. For purposes of this authorization, an IRA
beneficiary will not be treated as an affiliate of a person solely by
reason of being an employee of such person. Therefore, an IRA
beneficiary is not precluded from providing the authorization required
under paragraph (b)(5)(i) merely because the IRA beneficiary is an
employee of the fiduciary adviser. Paragraph (b)(5)(iii) provides that
a plan sponsor is not treated as a person providing a designated
investment option under the plan merely because one of the designated
investment options of the plan is an option that permits investment in
securities of the plan sponsor or an affiliate. Therefore, a plan
sponsor-fiduciary is not precluded from providing the authorization
required by paragraph (b)(5)(i) merely because the plan includes
qualifying employer securities as a designated investment option.
Paragraph (b)(5)(ii) addresses authorization in connection with the
adviser's own plan. This provision accommodates a fiduciary adviser's
provision of investment advice to its own employees (or employees of an
affiliate) pursuant to an arrangement under the final rule, provided
that the fiduciary adviser or affiliate offers the same arrangement to
participants and beneficiaries of unaffiliated plans in the ordinary
course of its business. The Department notes, however, that the
statutory exemption does not provide relief for the selection of the
fiduciary adviser or the arrangement pursuant to which advice will be
provided. Accordingly, a plan fiduciary must nonetheless be prudent in
its selection and may not, in contravention of ERISA section 406(b),
use its position to benefit itself or a person in which such fiduciary
has an interest that may affect the exercise of such fiduciary's best
judgment as a fiduciary. In this regard, the Department has indicated
that if a fiduciary provides services to a plan without the receipt of
compensation or other consideration (other than reimbursement of direct
expenses properly and actually incurred in the performance of such
services) the provision of such services does not, in and of itself,
constitute an act described in section 406(b).\28\
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\28\ See 29 CFR 2550.408b-2(e)(3).
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One commenter asked whether paragraph (b)(5) requires authorization
by the employer or the IRA beneficiary with respect to an employer-
sponsored SIMPLE IRA. Savings Incentive Match Plan for Employees
(SIMPLE) IRA plans and Simplified Employee Pension (SEP) plans are
relatively uncomplicated IRA-based retirement savings vehicles that
allow contributions to be made on a tax-favored basis to individual
retirement accounts and individual retirement annuities (IRAs) owned by
the employees. Although generally a SEP or SIMPLE IRA is a plan subject
to Title I of ERISA, many of the rules applicable to other ERISA-
covered employer sponsored pension plans do not apply to SIMPLE IRA and
SEP plans.\29\ For example, SIMPLE IRA and SEP plans are subject to
minimal reporting and disclosure requirements.\30\ Many employers that
sponsor these IRA-based plans that are intended to be
[[Page 66145]]
uncomplicated to establish and administer may not be willing to assume
the duty to authorize an investment advice provider under the
regulation, even one selected by an IRA beneficiary. This could limit
access to fiduciary investment advice under the regulation for the
participants and beneficiaries of such IRA-based plans. Under these
circumstances, the Department has defined the term ``IRA'' in this
regulation to include a ``simplified employee pension'' described in
section 408(k) of the Code, and a ``simple retirement account''
described in section 408(p) of the Code. Thus, SIMPLE IRA plans and SEP
plans would be treated like IRAs under the requirements of the final
regulation, and the required authorization would be given by the
participant or beneficiary to whom the account belongs and who receives
the advice. The Department is interested in continuing to receive
public input on the operation of the regulation in the context of
SIMPLE IRA plans and SEP plans, especially the experience of
participants and beneficiaries and, to the extent public input suggests
that changes in this context are necessary, the Department may consider
further adjustments to the regulation in the future.
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\29\ See ERISA sections 101(h) (application of reporting
requirements) and 404(c)(2) (application of fiduciary responsibility
requirements). The Department treats SEP and SIMPLE IRA plans
differently from other ERISA-covered pension plans in other
contexts. See 29 CFR 2550.404a-5 (disclosures to participants in
participant-directed individual account plans) and 2550.408b-2(c)(1)
(disclosures to fiduciaries of pension plans).
\30\ 29 CFR 2520.104-48 and 2520.104-49.
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e. Annual Audit
Paragraph (b)(6) of the final rule sets forth the annual audit
requirements for the statutory exemption.\31\ Paragraph (b)(6)(i), like
the proposal, provides that the fiduciary adviser shall, at least
annually, engage an independent auditor, who has appropriate technical
training or experience and proficiency, and so represents in writing to
the fiduciary adviser, to conduct an audit of the adviser's investment
advice arrangements for compliance with the requirements of the
regulation and, within 60 days following completion of the audit, to
issue a written report to the fiduciary adviser and, except with
respect to an arrangement with an IRA, to each fiduciary who authorized
the use of the investment advice arrangement. The written report must
set forth the specific findings of the auditor regarding compliance of
the arrangement with the requirements of the regulation (paragraph
(b)(6)(i)(B)(4)). However, as discussed below, because of the
importance of the annual audit in helping an authorizing fiduciary
monitor compliance of the arrangement, paragraph (b)(6)(i)(B) of the
final rule, unlike the proposal, also enumerates certain basic
information about the audited arrangement that must be included in the
audit report. Specifically, the report must identify the fiduciary
adviser and the type of arrangement (i.e., fee leveling, computer
models, or both) (paragraphs (b)(6)(i)(B)(1) and (2)). Further, if the
arrangement uses computer models, or both computer models and fee
leveling, the report must also indicate the date of the most recent
computer model certification, and identify the eligible investment
expert that provided the certification (paragraph (b)(6)(i)(B)(3)). The
Department believes that this basic information will benefit the
authorizing fiduciary or IRA beneficiary in understanding the
arrangement without imposing a significant burden on the auditor, which
ordinarily will have such information.
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\31\ The audit provisions are set forth in section 408(g)(6) of
ERISA.
---------------------------------------------------------------------------
Given the significant number of reports that an auditor would be
required to send if the written report was required to be furnished to
all IRA beneficiaries, the Department framed an alternative requirement
for investment advice arrangements with IRAs. This alternative is set
forth in paragraph (b)(6)(ii) of the proposal and the final rule. Under
this provision, the fiduciary adviser must, within 30 days following
receipt of the report from the auditor as required under paragraph
(b)(6)(i)(B), furnish a copy of the report to the IRA beneficiary or
make such report available on its Web site, provided that such
beneficiaries are provided information, along with other required
participant disclosures (see paragraph (b)(7) of the final rule),
concerning the purpose of the report, and how and where to locate the
report applicable to their account. The Department believes that making
reports available on a Web site in this manner to IRA beneficiaries
satisfies the requirement of section 104(d)(1) of the Electronic
Signatures in Global and National Commerce Act (E-SIGN) \32\ that any
exemption from the consumer consent requirements of section 101(c) of
E-SIGN must be necessary to eliminate a substantial burden on
electronic commerce and will not increase the material risk of harm to
consumers. The Department solicited comments on this finding in
connection with the prior proposal, and received no comments in
response.\33\
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\32\ 15 U.S.C. 7004(d)(1) (2000).
\33\ See 74 FR 3829 (Jan. 21, 2009).
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Obtaining consent from each IRA holder or participant before
publication on the Web site would be a tremendous burden on the plan or
IRA provider. This element, along with the broad availability of
Internet access and the lack of any direct consequences to any
particular participant for a failure to review the audit for the
participants and beneficiaries, supports these findings.
As with the proposal, paragraph (b)(6)(ii) of the final rule also
provides with respect to an arrangement with an IRA that, if the report
of the auditor identifies noncompliance with the requirements of the
regulation, then the fiduciary adviser must send a copy of the report
to the Department. The final rule, like the proposal, requires that the
fiduciary adviser submit the report to the Department within 30 days
following receipt of the report from the auditor. This report will
enable the Department to monitor compliance with the statutory
exemption.
Some commenters expressed concern with the requirement in paragraph
(b)(6)(ii)(B) that the fiduciary adviser must send a copy of the
auditor's report to the Department if that report identifies instances
of noncompliance. They recommended that reports only be required to be
filed with the Department when there is ``material'' noncompliance.
Other commenters recommended that fiduciary advisers be afforded a
period within which to self-correct prior to the reporting of
noncompliance. This filing requirement will enable the Department to
monitor compliance with the exemption in those instances where there is
no authorizing ERISA plan fiduciary to carry out that function. While
it recognizes that not every instance of noncompliance would, itself,
affect the quality of the advice provided to an IRA beneficiary, the
Department believes that, given the overall significance of the audit
as a protection for advice recipients, all reports that identify
noncompliance in this area should be furnished to the Department for
review, thereby giving it the opportunity to evaluate the significance
of the noncompliance, the function that an authorizing plan fiduciary
would carry out for its plan. Accordingly, the Department is adopting
the filing requirement as proposed without substantive change. We note,
however, that language has been added to paragraph (b)(6)(ii)(B) to
provide a means for electronic submission to the Department.
A commenter suggested that plan participants should be informed of
audit results. The Department does not believe it is appropriate as
part of the final rule, without further notice and comment, to adopt
such a requirement, which could involve a significant number of audit
reports being furnished to plan participants. The Department believes
that the furnishing of the audit report to the authorizing plan
fiduciary, who must act prudently and solely in
[[Page 66146]]
the interest of plan participants, is sufficient to protect the
interests of participants and beneficiaries. The fiduciary should
examine the audit report furnished and, if noncompliance is identified,
take appropriate steps. Because of the importance of the audit report,
the Department has included a new provision, at paragraph (b)(8), which
requires that the fiduciary adviser provide the authorizing fiduciary
with written notification that the fiduciary adviser intends to comply
with the statutory exemption and the regulations and that the fiduciary
adviser's investment advice arrangement will be audited annually by an
independent auditor for compliance, and that the auditor will furnish
the authorizing fiduciary with a copy of that auditor's findings within
60 days of its completion of the audit. This disclosure serves to place
the authorizing fiduciary on notice that an audit will be conducted
annually and that a report of that audit will be furnished. The
Department would expect the authorizing fiduciary to take reasonable
steps if the report is not furnished in a timely manner, such as making
inquiries with the auditor, the fiduciary adviser, or both.
With regard to the person who conducts the audit, one commenter
recommended that the auditor should be treated as a fiduciary. Others
asked if the audit must be conducted by a certified public accountant.
Another requested that the final rule provide additional guidance with
respect to necessary credentials to conduct an audit, such as minimum
standards of experience, education, or professional certification or
licensing. As with the requirements for an ``eligible investment
expert,'' the Department does not believe there is necessarily one set
of credentials, such as being a certified public accountant, auditor,
or lawyer, that qualifies an individual to conduct the required audits.
In addition to any licenses, certifications or other evidence of
professional or technical training, a fiduciary adviser will want to
consider the relevance of that training to the required audit, as well
as the individual's or organization's experience and proficiency in
conducting similar types of audits. In this regard, because the
selection of an auditor is a fiduciary act (see paragraph (b)(6)(v)), a
fiduciary adviser's selection must be carried out in a manner
consistent with the prudence requirements of section 404(a)(1), taking
into account the nature and scope of the audit and the expertise and
experience necessary to conduct such an audit.
Paragraph (b)(6)(iii) describes the circumstances under which an
auditor will be considered independent for purposes of paragraph
(b)(6). As proposed, this paragraph required that the auditor not have
a material affiliation or material contractual relationship with the
person offering the investment advice arrangement to the plan or any
designated investment options under the plan. The terms ``material
affiliation'' and ``material contractual relationship'' are defined in
paragraphs (c)(6) and (7) of the final rule, respectively. Some
commenters asked whether an auditor's provision of certain services
(e.g., computer model certification required under the regulation)
would disqualify the auditor. The Department believes that the 10%
gross revenue test in the definition of the term ``material contractual
relationship,'' which contemplates that there may be instances in which
an auditor might be performing other services for a fiduciary adviser
or affiliates, generally is sufficient to minimize any influence on the
part of the fiduciary adviser by virtue of service relationships that
would serve to compromise the independence of the auditor. However, if
an auditor participates in the development of a fiduciary adviser's
investment advice arrangement, then the auditor would appear to be in a
position of auditing its own work for compliance with the exemption.
The Department does not believe such an auditor is sufficiently
independent for purposes of the regulation. Similarly, in the case of
an investment advice arrangement that uses computer modeling, because
an auditor would be in the position of determining whether the person
who certifies a computer model, as required by paragraph (b)(4)(ii),
has any relationship that would preclude it from acting as an
``eligible investment expert'' as defined in paragraph (b)(4)(iii), the
Department does not believe an auditor may also act as the computer
model certifier. Paragraph (b)(6)(iii) has been modified accordingly.
With regard to the scope of the audit, paragraph (b)(6)(iv) of the
final rule provides that the auditor shall review sufficient relevant
information to formulate an opinion as to whether the investment advice
arrangements, and the advice provided pursuant thereto, offered by the
fiduciary adviser during the audit period were in compliance with the
regulation. Paragraph (b)(6)(iv) further provides that it is not
intended to preclude an auditor from using information obtained by
sampling, as reasonably determined appropriate by the auditor,
investment advice arrangements, and the advice pursuant thereto, during
the audit period. The final rule, like the proposal, does not require
an audit of every investment advice arrangement at the plan or
fiduciary adviser-level or of all the advice that is provided under the
exemption. In general, the final rule appropriately leaves to the
auditor the determination of how to conduct its review, including the
extent to which it can rely on representative samples for determining
compliance with the exemption.
A number of comments requested clarification with respect to the
conduct and scope of the audit. Several commenters asked whether each
plan, IRA, and participant and beneficiary must be included. A
commenter also asked whether the audit could be performed by only
reviewing documentation of compliance with the fiduciary adviser's
internal compliance policies and procedures. As discussed above, the
audit provisions of the final rule require that the auditor review
sufficient information to formulate an opinion as to whether the
investment advice arrangements, and the advice provided pursuant
thereto, are in compliance with the final rule. Accordingly, the
methods used to conduct the audit are to be determined by the auditor.
The Department does note, however, that nothing in these provisions
precludes the auditor from using sampling, as determined reasonably
appropriate by the auditor, of investment advice arrangements and
investment advice. The Department expects that the sample used by an
auditor will depend on the facts and circumstances encountered. For
example, an auditor may initially believe that the most appropriate way
to make the required findings is to construct a sample that represents
a subset of all advice arrangements of a fiduciary adviser, and advice
provided. In testing the sample, however, the auditor should look for,
and may find, patterns of compliance failures that indicate that
certain areas are more prone to compliance failures than others. If
such patterns appear, the auditor may need to expand the sample to more
accurately assess the extent and causes of noncompliance. While the
Department believes that internal policies and procedures, if
reasonably designed and followed, can be helpful to a fiduciary adviser
to ensure compliance with the requirements of the regulation, the
Department does not believe it would be appropriate for an
[[Page 66147]]
auditor to limit, in any way, the conduct of its audit to an
examination of compliance with those policies and procedures.
Another commenter appeared to suggest development of audit
alternatives for fiduciary advisers that are regulated and subject to
periodic examination by other agencies. This commenter, however, did
not include sufficient information for further consideration. The
Department notes, moreover, that section 408(g)(6) of ERISA requires an
annual audit for compliance with the exemption.
Paragraph (b)(6)(v) of the final rule, like the proposal, provides
that for purposes of the statutory exemption, the selection of an
auditor is a fiduciary act governed by section 404(a)(1) of ERISA. In
response to a question from a commenter, the Department notes that, in
its view, the performance of an audit under the final rule would not,
by itself, cause an auditor to be a fiduciary under ERISA.
f. Disclosure to Participants
As in the proposal, paragraph (b)(7) of the final rule sets forth a
number of requirements involving disclosures to participants and
beneficiaries that are based on, and generally track, the disclosure
requirements contained in section 408(g)(6).
Paragraph (b)(7)(i) generally requires that the fiduciary adviser
provide to participants and beneficiaries without charge, prior to the
initial provision of investment advice with regard to any security or
other property offered as an investment option, a written notification
describing: the role of any party that has a material affiliation or
material contractual relationship with the fiduciary adviser in the
development of the investment advice program and in the selection of
investment options available under the plan; the past performance and
historical rates of return of the designated investment options
available under the plan, to the extent that such information is not
otherwise provided; all fees or other compensation relating to the
advice that the fiduciary adviser or any affiliate thereof is to
receive (including compensation provided by any third party) in
connection with the provision of the advice, the sale, acquisition, or
holding of the security or other property pursuant to such advice, or
any rollover or other distribution of plan assets or the investment of
distributed assets in any security or other property pursuant to such
advice; and any material affiliation or material contractual
relationship of the fiduciary adviser or affiliates thereof in the
security or other property.
The notification to participants and beneficiaries also is required
to explain: the manner, and under what circumstances, any participant
or beneficiary information provided under the arrangement will be used
or disclosed; the types of services provided by the fiduciary adviser
in connection with the provision of investment advice by the fiduciary
adviser; that the adviser is acting as a fiduciary of the plan in
connection with the provision of the advice; and that a recipient of
the advice may separately arrange for the provision of advice by
another adviser that could have no material affiliation with and
receive no fees or other compensation in connection with the security
or other property. Because the computer model exception for qualifying
employer securities has been removed from paragraph (b)(4)(i)(G)(2),
explained above, the language in paragraph (b)(7)(i)(F) of the proposal
that required the notification to include any limitations with respect
to a computer model's ability to take into account qualifying employer
securities also has been removed.
Paragraph (b)(7)(ii)(A) of the final rule requires that the
notification furnished to participants and beneficiaries must be
written in a clear and conspicuous manner and in a manner calculated to
be understood by the average plan participant and must be sufficiently
accurate and comprehensive to reasonably apprise such participants and
beneficiaries of the information required to be provided in the
notification.
Paragraph (b)(7)(ii)(B) of the final rule references the
availability of a model disclosure form in the appendix to the final
rule. As with the proposal, the model disclosure form may be used for
purposes of satisfying the requirements set forth in paragraph
(b)(7)(i)(C), as well as the requirements of paragraph (b)(7)(ii)(A) of
the final rule. The final rule, like the proposal, makes clear,
however, that the use of the model disclosure form is not mandatory.
The Department received a number of comments related to the
contents and timing of the disclosures required under paragraph (b)(7).
One commenter suggested that the final rule require the disclosure be
provided at least 14 days before the initial provision of investment
advice, and further require that each advice session be accompanied by
a summary disclosure that includes a subset of the information required
under the proposal (e.g., fees or other compensation that may be
received, and that the adviser is acting as a fiduciary). Another
commenter recommended disclosure of each investment option's
profitability to the fiduciary advisers or their affiliates, suggesting
that this would enable participants to better understand the advisers'
financial interests. In contrast, another commenter stated that
requiring disclosure of ``all'' fees or other compensation could
overwhelm participants and beneficiaries with information, and that the
Department should instead adopt a materiality standard for such
disclosure. Another commenter suggested removal of the past return
information disclosure, arguing that participants may focus on
investments with the highest returns without considering or
understanding the associated risks. Another commenter suggested that
the provision should require disclosure of historical rates of return
at the asset class level, rather than the individual investment level.
Others also indicated the practical difficulties in providing the
proposal's disclosures for plans with numerous investment options, and
requested that the Department consider more limited disclosures.
After consideration of the comments received, the Department
believes that the statutory disclosure framework, reflected in both the
proposal and final rule, strikes the appropriate balance in terms of
ensuring participants and beneficiaries have the information to assess
the potential for conflicts of interest and compensation of the
fiduciary adviser.
Some commenters requested that the Department clarify that the
required disclosures may be combined with other disclosures the adviser
is required to furnish under securities or other laws. It is the view
of the Department that nothing in the final rule forecloses the use of
other materials for making the disclosures required by the final rule,
so long as the understandability and clarity of the disclosures is not
compromised by virtue of their inclusion in such other materials and
the requirements of paragraph (b)(7)(ii)(A) are satisfied.
Like the proposal, paragraph (b)(7)(iii) of the final rule provides
that the required notifications may, in accordance with 29 CFR
2520.104b-1, be furnished in either written or electronic form. Some
commenters requested more flexibility for electronic disclosures than
is permitted under 29 CFR 2520.104b-1. Others, however, suggested more
limited use of electronic disclosures. Because the Department currently
is reviewing issues related to use of electronic media to furnish
information to participants and beneficiaries, this provision has not
[[Page 66148]]
been changed from the proposal in response to these comments.\34\
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\34\ See 76 FR 19285 (Apr. 7, 2011).
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Paragraph (b)(7)(iv) of the final rule sets forth miscellaneous
recordkeeping and furnishing responsibilities of the fiduciary adviser.
Specifically, this paragraph requires that, at all times during the
provision of advisory services to the participant or beneficiary
pursuant to the arrangement, the fiduciary adviser must: Maintain the
information required to be disclosed to participants and beneficiaries
in accurate form; provide, without charge, accurate, up-to-date
disclosures to the recipient of the advice no less frequently than
annually; provide, without charge, accurate information to the
recipient of the advice upon request of the recipient; and provide,
without charge, to the recipient of the advice any material change to
the required information at a time reasonably contemporaneous to the
change in information. These provisions are being adopted in the final
rule without substantive change from the proposal.
g. Disclosure to Authorizing Fiduciary
As discussed in more detail above in connection with the audit
provision, paragraph (b)(8) of the final rule is a new provision that
requires disclosure of certain information to the fiduciary that
authorizes an investment advice arrangement. Under this provision, the
fiduciary adviser must provide the authorizing fiduciary with a written
notification that the fiduciary adviser intends to comply with the
conditions of the statutory exemption for investment advice under
section 408(b)(14) and (g) and this regulation. The notification also
must inform the authorizing fiduciary that the fiduciary adviser's
arrangement will be audited annually by an independent auditor for
compliance with the requirements of the statutory exemption and this
regulation, and that the auditor will furnish the authorizing fiduciary
a copy of that auditor's findings within 60 days of its completion of
the audit.
Because paragraph (b)(5) of the rule already requires authorization
by an independent fiduciary, the Department does not believe the
notification requirement in paragraph (b)(8) will impose a significant
additional burden on fiduciary advisers.
h. Other Conditions
Paragraph (b)(9) of the final rule, like paragraph (b)(8) of the
proposal, sets forth the additional requirements contained in section
408(g)(7) of ERISA that apply to the provision of investment advice
under the statutory exemption. These requirements are as follows: The
fiduciary adviser must provide appropriate disclosure, in connection
with the sale, acquisition, or holding of the security or other
property, in accordance with all applicable securities laws (paragraph
(b)(9)(i)); any sale, acquisition, or holding of a security or other
property occurs solely at the direction of the recipient of the advice
(paragraph (b)(9)(ii)); the compensation received by the fiduciary
adviser and affiliates thereof in connection with the sale,
acquisition, or holding of the security or other property is reasonable
(paragraph (b)(9)(iii)); and the terms of the sale, acquisition, or
holding of the security or other property are at least as favorable to
the plan as an arm's length transaction would be (paragraph
(b)(9)(iv)). This provision is unchanged from the corresponding
provision of the proposal.
A commenter described a situation where an IRA owner or participant
gives standing instructions to rebalance his or her portfolio on a pre-
determined basis (which the commenter referred to as ``ministerial
rebalancing'') and another situation where changes to a portfolio are
permitted when a model changes and the client receives advance notice
(which the commenter referred to as ``re-optimization'' or ``re-
allocation''), and asked whether these were consistent with the
requirement in paragraph (b)(9)(ii) that any sale, acquisition or
holding of a security or other property occurs solely at the direction
of the recipient of the advice.
In general, it is the view of the Department that a pre-
authorization for a fiduciary adviser to maintain a particular asset
allocation structure for a participant's portfolio by periodic
rebalancing of investments would not violate the ``solely at the
direction'' requirement in paragraph (b)(9)(ii), provided that such
maintenance does not involve the exercise of discretion on the part of
the fiduciary adviser, that is, when a participant is informed of and
approves, at the time of the authorization, the specific circumstances
under which a rebalancing of his or her portfolio will take place and
the particular investments that will be utilized for such rebalancing.
If, on the other hand, the particular investments that might be
utilized for purposes of rebalancing a participant's account are not
known and the fiduciary adviser is given the discretion to select the
required investments, it is the view of the Department that, in order
to avoid violating paragraph (b)(9)(ii), the participant must be
afforded advance notice of the fiduciary adviser's intended investments
and a reasonable opportunity, generally at least 30 days, to object to
the investments. With respect to a different asset allocation
structure, the Department believes that the participant or beneficiary
must make an affirmative direction for its implementation.
i. Definitions
Paragraph (c) sets forth definitions of terms used in the final
rule.
Paragraph (c)(1) defines the term ``designated investment option.''
The term ``designated investment option'' means any investment option
designated by the plan into which participants and beneficiaries may
direct the investment of assets held in, or contributed to, their
individual accounts. The term ``designated investment option'' shall
not include ``brokerage windows,'' ``self-directed brokerage
accounts,'' or similar plan arrangements that enable participants and
beneficiaries to select investments beyond those designated by the
plan. The Department has added a cross-reference to clarify that the
term ``designated investment option'' has the same meaning as
``designated investment alternative'' as defined in 29 CFR 2550.404a-5
(relating to certain disclosures to participants).
Paragraph (c)(2) defines the term ``fiduciary adviser,'' as it
appears in section 408(g)(11)(A) of ERISA. A commenter suggested that
paragraph (c)(2)(ii), which treats a person who develops the computer
model or markets the investment advice program or computer model
utilized in satisfaction of paragraph (b)(4) as a fiduciary adviser, is
overly broad, and could result in higher costs overall and fewer
parties willing to provide these functions. In response, the Department
notes that such fiduciary status is conferred by statute at section
408(g)(11)(A). However, the Department further notes that Sec.
2550.408g-2, discussed in more detail below, permits one such fiduciary
to elect to be treated as a fiduciary with respect to the plan.
Paragraph (c)(3) defines the term ``registered representative'' as
set forth in ERISA section 408(g)(11)(C), which states that a
registered representative of another entity means a person described in
section 3(a)(18) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(18)) (substituting the entity for the broker or dealer referred
to in such section) or a person described in section 202(a)(17) of the
Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)(17)) (substituting
the entity for the
[[Page 66149]]
investment adviser referred to in such section).
Paragraph (c)(4), consistent with section 601(b)(3)(A)(i) of the
PPA, generally defines the term ``Individual Retirement Account'' or
``IRA'' for purposes of the final rule to mean plans described in
paragraphs (B) through (F) of section 4975(e)(1) of the Code, as well
as a trust, plan, account, or annuity which, at any time, has been
determined by the Secretary of the Treasury to be described in such
paragraphs. However, as explained above, paragraphs (c)(4)(vii) and
(c)(4)(viii) have been added to make clear that for purposes of the
regulation, the term ``IRA'' includes a ``simplified employee pension''
described in section 408(k) of the Code, and a ``simple retirement
account'' described in section 408(p) of the Code.
Like the proposal, paragraph (c)(5) of the final rule defines the
term ``affiliate.'' Under this provision, an ``affiliate'' of another
person means: Any person directly or indirectly owning, controlling, or
holding with power to vote, 5 percent or more of the outstanding voting
securities of such other person (paragraph (c)(5)(i)); any person 5
percent or more of whose outstanding voting securities are directly or
indirectly owned, controlled, or held with power to vote, by such other
person (paragraph (c)(5)(ii)); any person directly or indirectly
controlling, controlled by, or under common control with, such other
person (paragraph (c)(5)(iii)); and any officer, director, partner,
copartner, or employee of such other person (paragraph (c)(5)(iv)).
Consistent with ERISA section 408(g)(11)(B), this definition is based
on the definition of an ``affiliated person'' of an entity as contained
in section 2(a)(3) of the Investment Company Act of 1940 (ICA) (15
U.S.C. sec. 80a-2(a)(3)), except that it does not reflect clauses (E)
and (F) thereof. The Department has determined that including
provisions similar to clauses (E) and (F) is unnecessary, because these
clauses appear to focus on persons who exercise control over the
management of an investment company.\35\ These persons would be treated
as affiliates under paragraph (c)(5)(iii) of the final rule because
they would be persons directly or indirectly controlling, controlled
by, or under common control with, such other person.
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\35\ ICA section 2(a)(3)(E) and (F) include in the definition of
an affiliated person: If the other person is an investment company,
any investment adviser thereof or any member of an advisory board
thereof; and if such other person is an unincorporated investment
company not having a board of directors, the depositor thereof. 15
U.S.C. 80a-2(a)(3)(E)-(F).
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A number of commenters presented factual questions on the
definition of ``affiliate'' in paragraph (c)(5). These have not been
addressed here because of their inherently factual nature.
One comment requested that the Department instead adopt the
definition of ``affiliate'' that applies under 29 CFR 2510.3-21. For
purposes of that regulation, an ``affiliate'' of a person includes: Any
person directly or indirectly, through one or more intermediaries,
controlling, controlled by, or under common control with such person;
any officer, director, partner, employee or relative (as defined in
ERISA section 3(15)) of such person; and any corporation or partnership
of which such person is an officer, director or partner.\36\ Because
section 408(g)(11)(B) of ERISA defines the term ``affiliate'' for
purposes of the statutory exemption specifically by reference to the
definition in section 2(a)(3) of the ICA, the Department has not
adopted this comment.
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\36\ 29 CFR 2510.3-21(e)(1).
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In a variety of places, the final rule refers to persons with
``material affiliations'' or ``material contractual relationships,''
which are defined in paragraphs (c)(6) and (c)(7), respectively.
Paragraph (c)(6)(i) of the final rule describes a person with a
``material affiliation'' with another person as: Any affiliate of the
other person; any person directly or indirectly owning, controlling, or
holding, 5 percent or more of the interests of such other person; and
any person 5 percent or more of whose interests are directly or
indirectly owned, controlled, or held, by such other person. Paragraph
(c)(6)(ii) provides that, for these purposes, an ``interest'' means
with respect to an entity: The combined voting power of all classes of
stock entitled to vote or the total value of the shares of all classes
of stock of the entity if the entity is a corporation; the capital
interest or the profits interest of the entity if the entity is a
partnership; or the beneficial interest of the entity if the entity is
a trust or unincorporated enterprise.
Paragraph (c)(7) of the final rule provides that persons shall be
treated as having a ``material contractual relationship'' if payments
made by one person to the other person pursuant to written contracts or
agreements between the persons exceed 10 percent of the gross revenue,
on an annual basis, of such other person. The Department notes that
this 10% gross revenue test is not limited to amounts paid pursuant to
contracts or arrangements that have been reduced to writing.\37\
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\37\ See 74 FR 3822 (Jan. 21, 2009) (explaining corresponding
language in the 2009 final rule).
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Lastly, paragraph (c)(8) defines ``control'' to mean the power to
exercise a controlling influence over the management or policies of a
person other than an individual.
j. Retention of Records
As with the proposal, paragraph (d) of the final rule sets forth
the record retention requirements applicable to an eligible investment
advice arrangement. Consistent with section 408(g)(9) of ERISA,
paragraph (d) provides that the fiduciary adviser must maintain, for a
period of not less than 6 years after the provision of investment
advice under the section any records necessary for determining whether
the applicable requirements of the final rule have been met, noting
that a transaction prohibited under section 406 of ERISA shall not be
considered to have occurred solely because the records are lost or
destroyed prior to the end of the 6-year period due to circumstances
beyond the control of the fiduciary adviser.
k. Noncompliance
Paragraph (e) of the final rule, like the proposal, specifically
addresses the consequences of noncompliance with the regulation. This
provision makes clear that the prohibited transaction relief described
in paragraph (b) of the regulation will not apply to any transaction
with respect to which the applicable conditions of the final rule have
not been satisfied. Further, in the case of a pattern or practice of
noncompliance with any of the applicable conditions of the final rule,
the relief will not apply to any transaction in connection with the
provision of investment advice provided by the fiduciary adviser during
the period over which the pattern or practice extended. With respect to
what would constitute a ``pattern or practice,'' the Department
believes that it is important to identify both individual violations
and patterns of such violations. Isolated, unrelated, or accidental
occurrences would not themselves constitute a pattern or practice.
However, intentional, regular, deliberate practices involving more than
isolated events or individuals, or institutionalized practices will
almost always constitute a pattern or practice. In determining whether
a pattern or practice exists, the Department will consider whether the
noncompliance appears to be part of either written or unwritten
policies or established
[[Page 66150]]
practices, whether there is evidence of similar noncompliance with
respect to more than one plan or arrangement, and whether the
noncompliance is within a fiduciary adviser's control.
This provision is being adopted without change from the proposal.
The Department believes that one of the most significant deterrents to
noncompliance with the conditions of the statutory exemption is the
potentially significant excise taxes applicable to transactions that
fail to satisfy its conditions, and that extending the potential for
excise taxes to encompass a period over which a pattern or practice of
noncompliance extends creates additional incentives on the part of
fiduciary advisers that take advantage of the exemptive relief to be
vigilant in assuring compliance.
l. Effective Date
The Department proposed that the regulation would be effective 60
days after the date of publication of the final rule. One commenter
indicated that the 60 day effective date would not constitute
sufficient time to comply with the final rule, and suggested the
effective date should be extended to 180 days after publication of the
final rule.
Given the importance of investment advice to participants and
beneficiaries generally and given that the exemption implemented in the
final rule will expand the opportunity for participant and
beneficiaries to obtain affordable, quality investment advice, the
Department believes that the final rule should be effective on the
earliest possible date, and has not made the suggested change.
Accordingly, the final rule contained in this document will be
effective 60 days after the date of publication in the Federal Register
and will apply to transactions described in paragraphs (b) of the final
rule occurring on or after that date.
m. Miscellaneous
A number of commenters made suggestions beyond the scope of this
regulation that they believed would additionally benefit participants
and beneficiaries. These suggestions were not adopted by the
Department.
C. Overview of Final Sec. 2550.408g-2 and Public Comments
Section 408(g)(11)(A) of ERISA provides that, with respect to an
arrangement that relies on use of a computer model to qualify as an
``eligible investment advice arrangement'' under the statutory
exemption, a person who develops the computer model, or markets the
investment advice program or computer model, shall be treated as a
fiduciary of a plan by reason of the provision of investment advice
referred to in ERISA section 3(21)(A)(ii) to the plan participant or
beneficiary. Such a person also shall be treated as a ``fiduciary
adviser'' for purposes of ERISA sections 408(b)(14) and 408(g). The
Secretary of Labor, however, may prescribe rules under which only one
fiduciary adviser may elect to be treated as a fiduciary with respect
to the plan. Section 4975(f)(8)(J)(i) of the Code contains a parallel
provision to ERISA section 408(g)(11)(A) that applies for purposes of
Code sections 4975(d)(17) and 4975(f)(8).
In conjunction with the proposed regulation implementing the
statutory exemption for investment advice, the Department also proposed
a rule, Sec. 2550.408g-2, governing the requirements for electing to be
treated as a fiduciary and fiduciary adviser by reason of developing or
marketing a computer model or an investment advice program used in an
eligible investment advice arrangement. Section 2550.408g-2 sets forth
requirements that must be satisfied in order for one such fiduciary
adviser to elect to be treated as a fiduciary with respect to a plan
under such an eligible investment advice arrangement. See paragraph (a)
of Sec. 2550.408g-2.
Paragraph (b)(1) of Sec. 2550.408g-2 provides that, if an election
meets the requirements of paragraph (b)(2), then the person identified
in the election shall be the sole fiduciary adviser treated as a
fiduciary by reason of developing or marketing a computer model, or
marketing an investment advice program, used in an eligible investment
advice arrangement. Paragraph (b)(2) requires that the election be in
writing and that the writing identify the arrangement, and person
offering the arrangement, with respect to which the election is to be
effective. The writing also must identify the electing person. Under
paragraph (b)(2)(ii), the electing person must: fall within any of
paragraphs (c)(2)(i)(A) through (E) of Sec. 2550.408g-1; develop the
computer model or market the computer model or investment advice
program; and acknowledge that it elects to be treated as the only
fiduciary, and fiduciary adviser, by reason of developing such computer
model or marketing such computer model or investment advice program.
Paragraph (b)(2) of Sec. 2550.408g-2 requires that the election be
signed by the person acknowledging that it elects to be treated as the
only fiduciary and fiduciary adviser; that a copy of the election be
furnished to the person who authorized use of the arrangement; and that
the writing be retained in accordance with the record retention
requirements of Sec. 2550.408g-1(d).
The Department notes that this election applies only for purposes
of limiting fiduciary status that results from developing or marketing
a computer model or investment advice program used under the statutory
exemption. It would not, for example, permit a fiduciary adviser who
actually renders investment advice to participants or beneficiaries to
avoid fiduciary status.
The Department received no substantive comments on this regulation
and, therefore, is adopting the regulation substantially as proposed.
This regulation, like Sec. 2550.408g-1, will be effective 60 days after
the date of publication of the final rule in the Federal Register.
D. Regulatory Impact Analysis
Regulatory Procedures
Executive Order 12866 ``Regulatory Planning and Review'' and Executive
Order 13563 ``Improving Regulation and Regulatory Review''
Executive Orders 12866 and 13563 direct agencies to assess all
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects, distributive impacts, and equity). Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, of reducing costs, of harmonizing rules, and of promoting
flexibility. Executive Order 12866 and 13563 require a comprehensive
regulatory impact analysis be performed for any economically
significant regulatory action, defined as an action that would result
in an annual effect of $100 million or more on the national economy or
which would have other substantial impacts. In accordance with OMB
Circular A-4, the Department has examined the economic and policy
implications of this final rule and has concluded that the action's
benefits justify its costs.
Summary of Impacts
The provisions of this final regulation reflect the Department's
efforts to ensure that the advice provided pursuant to them will be
affordable and of high quality. The results of this final regulation
will depend on its impacts on the availability, cost, use, and quality
of participant investment advice. The
[[Page 66151]]
Department anticipates that, as a result of these actions, quality,
affordable expert investment advice will proliferate, producing
significant net gains for participant-directed defined contribution
(DC) plan participants and beneficiaries and beneficiaries of
individual retirement accounts (IRAs) (collectively hereafter,
``participants''). The improved investment results will reflect
reductions in investment errors such as poor trading strategies and
inadequate diversification.
The Department estimates that this final rule will yield benefits
of between $7 billion and $18 billion annually, at a cost of between $2
billion and $5 billion, thereby producing a net financial benefit of
between $5 billion and $13 billion. The estimated costs of the final
regulation include costs of approximately $745 million that are
associated with the Paperwork Reduction Act information collection
requests contained in the final rule. Table 1 below presents these
average annual real benefits and costs given a ten year horizon with
discount rates of 3 percent and 7 percent.
Table 1--Accounting Statement
--------------------------------------------------------------------------------------------------------------------------------------------------------
Estimates Units
------------------------------------------------------------------------------------
Category Low High Discount Period
Primary estimate estimate estimate Year dollar rate covered
--------------------------------------------------------------------------------------------------------------------------------------------------------
Benefits:
Annualized..................................................... 13,200.0 7,000.0 18,300.0 2009 7% 2011-2020
Monetized ($millions/year)..................................... 13,200.0 7,000.0 18,300.0 2009 3% 2011-2020
Annualized..................................................... 0.0 0.0 0.0 ........... 7%
Quantified..................................................... 0.0 0.0 0.0 ........... 3%
------------------------------------------------------------------------------------
Qualitative.................................................... In addition to the quantified benefits, the Department anticipates that the
regulation will improve aggregate investment results, reflecting reduced
participants' investment related expenses, and will improve the welfare of
participants by better aligning participant investments and their risk tolerances.
Notes.......................................................... The regulation is anticipated to extend quality, expert investment advice to a
significantly greater number of participants. This will improve aggregate
investment results, reflecting reductions in investment errors (including poor
trading strategies and inadequate diversification).
------------------------------------------------------------------------------------
Costs:
Annualized..................................................... 3,700.0 1,900.0 5,100.0 2009 7% 2011-2020
Monetized ($millions/year)..................................... 3,700.0 1,900.0 5,100.0 2009 3% 2011-2020
Annualized..................................................... 0.0 0.0 0.0 ........... 7%
Quantified..................................................... 0.0 0.0 0.0 ........... 3%
Qualitative
------------------------------------------------------------------------------------
Notes.......................................................... The costs of this regulation are due to the direct cost of providing (or paying
for) investment advice, including approximately $745 million that are associated
with the Paperwork Reduction Act information collection requests contained in this
final rule.
------------------------------------------------------------------------------------
Transfers.......................................................... Not applicable.
------------------------------------------------------------------------------------
Effects:
State, Local, and/or Tribal Government......................... Not applicable.
Small Business................................................. Not applicable.
Wages.......................................................... Not applicable.
------------------------------------------------------------------------------------
Growth......................................................... The regulation may also have macroeconomic consequences, which are likely to be
small but positive.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Need for Regulatory Action
With the growth of participant-directed retirement savings
accounts, the retirement income security of America's workers
increasingly depends on their investment decisions. Unfortunately,
there is evidence that many participants of these retirement accounts
often make costly investment errors due to flawed information or
reasoning. As more fully discussed in the Benefits section below, these
participants may make financial mistakes which result in lower asset
accumulation, and thus final retirement account balances, for these
individuals and/or result in less than optimal levels of compensated
risk. Financial losses (including foregone earnings) from such mistakes
likely amounted to more than $114 billion in 2010.\38\ These losses
compound and grow larger as workers progress toward and into
retirement.
---------------------------------------------------------------------------
\38\ See 74 FR No 164 (Aug. 22, 2008), 74 FR No 12 (Jan. 21,
2009), and 75 FR No 40 (Mar. 2, 2010) for background on the analysis
contained in the Department's Regulatory Impact Analysis.
---------------------------------------------------------------------------
Such mistakes and consequent losses historically can be attributed
at least in part to provisions of the Employee Retirement Income
Security Act of 1974 that effectively preclude a variety of
arrangements whereby financial professionals might otherwise provide
retirement plan participants with expert investment advice.
Specifically, these ``prohibited transaction'' provisions of section
406 of ERISA and section 4975 of the Internal Revenue Code prohibit
fiduciaries from dealing with DC plan or IRA assets in ways that
advance their own interests. The prohibited transaction provisions
prohibit a fiduciary from dealing with the assets of a plan in his own
interest or for his own account and from receiving any consideration
for his own personal account from any party dealing with the plan in
connection with a transaction
[[Page 66152]]
involving the assets of the plan.\39\ These statutory provisions have
been interpreted as prohibiting a fiduciary from using the authority,
control or responsibility that makes it a fiduciary to cause itself, or
a party in which it has an interest that may affect its best judgment
as a fiduciary, to receive additional fees.\40\ As a result, in the
absence of a statutory or administrative exemption, fiduciaries are
prohibited from rendering investment advice to plan participants
regarding investments that result in the payment of additional advisory
and other fees to the fiduciaries or their affiliates. Section 4975 of
the Code applies similarly to the rendering of investment advice to an
individual retirement account (IRA) beneficiary.
---------------------------------------------------------------------------
\39\ ERISA section 406(b)(1) and (3) and Code section
4975(c)(1)(E) and (F).
\40\ 29 CFR 2550.408b-2(e).
---------------------------------------------------------------------------
Over the past several years, the Department has issued various
forms of guidance concerning when a person would be a fiduciary by
reason of rendering investment advice, and when such investment advice
might result in prohibited transactions.\41\ Responding to the need to
afford participants and beneficiaries greater access to professional
investment advice, Congress amended the prohibited transaction
provisions of ERISA and the Code, as part of the Pension Protection Act
of 2006 (PPA),\42\ to permit a broader array of investment advice
providers to offer their services to participants responsible for
investment of assets in their individual accounts and, accordingly, for
the adequacy of their retirement savings.
---------------------------------------------------------------------------
\41\ See Interpretative Bulletin relating to participant
investment education, 29 CFR 2509.96-1 (Interpretive Bulletin 96-1);
Advisory Opinion (AO) 2005-10A (May 11, 2005); AO 2001-09A (December
14, 2001); and AO 97-15A (May 22, 1997). In October 2010, the
Department proposed amendments to the regulation, at 29 CFR 2510.3-
21(c) that define when the provision of advice causes a person to be
a fiduciary.
\42\ Public Law 109-280, 120 Stat. 780 (Aug. 17, 2006).
---------------------------------------------------------------------------
Specifically, section 601 of the PPA added a statutory prohibited
transaction exemption under sections 408(b)(14) and 408(g) of ERISA,
with parallel provisions at Code sections 4975(d)(17) and
4975(f)(8).\43\ Section 408(b)(14) sets forth the investment advice-
related transactions that will be exempt from the prohibitions of ERISA
section 406 if the requirements of section 408(g) are met.\44\ These
requirements are met only if advice is provided by a fiduciary adviser
under an ``eligible investment advice arrangement.'' Section 408(g)
provides for two general types of eligible arrangements: one based on
compliance with a ``fee-leveling'' requirement (imposing limitation on
fees and compensation of the fiduciary adviser); the other, based on
compliance with a ``computer model'' requirement (requiring use of a
certified computer model). Both types of arrangements also must meet
several other requirements.
---------------------------------------------------------------------------
\43\ Under Reorganization Plan No. 4 of 1978 (43 FR 47713, Oct.
17, 1978), 5 U.S.C. App. 1, 92 Stat. 3790, the authority of the
Secretary of the Treasury to issue rulings under section 4975 of the
Code has been transferred, with certain exceptions not here
relevant, to the Secretary of Labor. Therefore, the references in
this notice to specific sections of ERISA should be taken as
referring also to the corresponding sections of the Code.
\44\ The transactions described in section 408(b)(14) are: the
provision of investment advice to the participant or beneficiary
with respect to a security or other property available as an
investment under the plan; the acquisition, holding or sale of a
security or other property available as an investment under the plan
pursuant to the investment advice; and the direct or indirect
receipt of compensation by a fiduciary adviser or affiliate in
connection with the provision of investment advice or the
acquisition, holding or sale of a security or other property
available as an investment under the plan pursuant to the investment
advice.
---------------------------------------------------------------------------
The Department's final investment advice regulation is needed to
provide additional guidance regarding the conditions set forth in the
PPA statutory exemption for investment advice. The Department
calibrated this final regulation to protect participants while
promoting the affordability of investment advice arrangements operating
pursuant to the PPA's statutory exemptive relief. The Department
expects that as a result of this regulatory action, high-quality,
affordable investment advice will proliferate, producing significant
net benefits for participants. For a further discussion of these
benefits, see the Benefits section below.
Benefits
The Department believes this final regulation will provide
important benefits to society by extending quality, expert investment
advice to more participants, leading them to make fewer investment
mistakes. As noted below, prior to implementation of the PPA,
investment mistakes cost participants approximately $114 billion in
2010 for participants, the Department estimates.\45\ The Department
believes that participants, after having received such advice, may pay
lower fees and expenses, engage in less excessive or poorly timed
trading, more adequately diversify their portfolios and thereby assume
less uncompensated risk, achieve a more optimal level of compensated
risk, and/or pay less excess taxes. The Department estimates that
advice available prior to the PPA reduced errors by $15 billion
annually (i.e., investment errors would have been $124 billion absent
this advice). Increased use of investment advice under the PPA will
incrementally reduce such mistakes by between $7 billion and $18
billion annually (roughly 6 percent to 16 percent of the $114 billion
in investment errors remaining after pre-PPA advise is given), the
Department estimates. Thus, the cumulative benefit of the pre-PPA
investment advice and the new investment advice under the PPA and this
final rule ranges between $22 billion and $33 billion. The Department's
estimates of the magnitude of these investment errors and the resulting
reductions from participants receiving investment advice are summarized
in Table 2 below. The sections below describe in more detail the
investment errors participants may make along with the method the
Department used to calculate the baseline, benefit and impact estimates
for this final regulation.
---------------------------------------------------------------------------
\45\ The Department bases these estimates upon the retirement
assets in DC plans and Individual Retirement Accounts reported by
the Federal Reserve Board's Flow of Funds Accounts (Mar. 2011), at
http://www.federalreserve.gov/releases/z1/Current/. This estimate is
subject to wide uncertainty. See 74 FR No 164 (Aug. 22, 2008), 74 FR
No 12 (Jan. 21, 2009), and 75 FR No 40 (Mar. 2, 2010) for the
details of the Department's Regulatory Impact Analysis.
Table 2--Long Term Investment Errors and Impact of Advice
[$Billions, annual]
------------------------------------------------------------------------
Errors eliminated by
Remaining advice
Policy context errors ---------------------------
Incremental Cumulative
------------------------------------------------------------------------
No advice....................... $124 $0 $0
Existing/Pre-PPA advice only 114 15 15
(Baseline).....................
New/PPA advice:
[[Page 66153]]
Low Estimate................ 96 7 22
Primary Estimate............ 101 13 28
High Estimates.............. 107 18 33
------------------------------------------------------------------------
Investment Mistakes
The Department believes that many participants make costly
investment mistakes and therefore could benefit from receiving and
following good advice. In theory, investors can optimize their
investment mix over time to match their investment horizon and personal
taste for risk and return. But in practice many investors do not
optimize their investments, at least not in accordance with generally
accepted financial theories.
Some investors fail to exhibit clear, fixed and rational
preferences for risk and return. Some base their decisions on flawed
information or reasoning. For example some investors appear to anchor
decisions inappropriately to plan features or to mental accounts or
frames, or to rely excessively on past performance measures or peer
examples. Some investors suffer from overconfidence, myopia, or simple
inertia.\46\ Such informational and behavioral problems translate into
at least five distinct types of investment mistakes.\47\
---------------------------------------------------------------------------
\46\ See, e.g., Richard H. Thaler & Shlomo Benartzi, The
Behavioral Economics of Retirement Savings Behavior, AARP Public
Policy Institute White Paper 2007-02 (Jan. 2007); and Jeffrey R.
Brown & Scott Weisbenner, Individual Account Investment Options and
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social
Science Research Network Abstract 631886 (Dec. 2004).
\47\ The Department notes that much of the research documenting
investment mistakes does not account for whether advice was present
or not. At least some of the mistakes may have been made despite
good advice to the contrary; some may have been made pursuant to bad
advice. There is evidence both that advice sometimes is not
followed, and that advice is sometimes bad. These issues are
explored more below.
---------------------------------------------------------------------------
Fees and Expenses
Two distinct types of inefficiency can result in higher than
optimal consumer expenditures for a particular type of good. The first
is prices that are higher than would be efficient. Efficient markets
require vigorous competition. Sellers with market power can command
inefficiently high prices, thereby capturing consumer surplus and
imposing a ``dead weight loss'' of welfare on society. Efficient
markets also require perfect information and rational, utility
maximizing consumers. Imperfect information, search costs and
consumers' behavioral biases likewise can allow some sellers to command
inefficiently high prices. The Department accordingly has considered
whether such conditions might exist in the market for investment
products and services bought by or on behalf of participants. The
second type of inefficiency is suboptimal consumer choices among
available products. Even if goods are priced competitively, welfare
will be lost if consumers make poor purchasing decisions. Imperfect
information, search costs and behavioral biases can compromise
purchasing decisions, and the Department has considered whether
participants' purchases of investment products and services might be so
compromised.
The Department believes that the research available at this time
provides an insufficient basis to confidently determine whether or to
what degree participants pay inefficiently high investment prices.\48\
Market conditions that may lead to inefficiently high prices--namely
imperfect information, search costs and investor behavioral biases--
certainly exist in the retail IRA market and likely exist to some
degree in particular segments of the DC plan market. The Department
believes there is a strong possibility that at least some participants,
especially IRA beneficiaries, pay inefficiently high investment prices.
If so, the Department would expect that quality advice reduces that
inefficiency. Such a reduction in inefficiencies would increase
participants' welfare by transferring economic surplus from producers
of investment products and services to participants and thereby
reducing societal dead weight loss. The Department additionally
believes that even where investment prices are efficient participants
often make bad investment decisions with respect to expenses--that is,
participants buy investment products and services whose marginal cost
exceed their associated marginal benefit.\49\ The Department expects
the PPA and this final regulation to reduce such investment errors,
improving participant and societal welfare. However, at this time the
Department has no basis on which to quantify such errors or
improvements.
---------------------------------------------------------------------------
\48\ See 74 FR No 164 (Aug. 22, 2008), 74 FR No 12 (Jan. 21,
2009), and 75 FR No 40 (Mar. 2, 2010) for background on the analysis
contained in the Department's Regulatory Impact Analysis.
\49\ It is possible that the converse could sometimes occur:
participants might fail to buy efficiently priced products and
services whose marginal cost lags their associated marginal benefit.
If so advice, by correcting this error, might lead to higher
expenses, but would still improve overall societal welfare. The
economic research suggests that participants are insensitive to fees
rather than excessively sensitive to fees, thus the Department
believes that the converse situation is likely to be rare.
---------------------------------------------------------------------------
Poor Trading Strategies
There is evidence that some participants trade excessively, while
many more participants trade too little, failing even to rebalance. In
DC plans, excessive participant trading often worsens performance, and
participants in accounts that are automatically rebalanced generally
fare best.\50\ Among inferior strategies, it is likely that active
trading aimed at timing the market generates more adverse results than
failing to rebalance. Many mutual funds investors' experience badly
lags the performance of the funds they hold because they buy and sell
shares too frequently and/or at the wrong times.\51\ Investors often
buy and sell in response to short-term past returns, and suffer as a
result.\52\ Good advice is likely to discourage market timing efforts
and encourage rebalancing, thereby
[[Page 66154]]
ameliorating adverse impacts from poor trading strategies.
---------------------------------------------------------------------------
\50\ See, e.g., Takeshi Yamaguchi et al., Winners and Losers:
401(k) Trading and Portfolio Performance, Michigan Retirement
Research Center Working Paper WP2007-154 (June 2007).
\51\ See, e.g., Dalbar Inc., Quantitative Analysis of Investor
Behavior 2007 (2007).
\52\ See, e.g., Rene Fischer & Ralf Gerhardt, Investment
Mistakes of Individual Investors and the Impact of Financial Advice,
Science Research Network Abstract 1009196 (Aug. 2007); Julie Agnew &
Pierluigi Balduzzi, Transfer Activity in 401(k) Plans, Social
Science Research Network Abstract 342600 (June 2006); and George
Cashman et al., Investor Behavior in the Mutual Fund Industry:
Evidence from Gross Flows, Social Science Research Network Abstract
966360 (Feb. 2007).
---------------------------------------------------------------------------
Inadequate Diversification
Investors sometimes fail to diversify adequately and thereby assume
uncompensated risk and suffer associated losses. For example, DC plan
participants sometimes concentrate their assets excessively in stock of
their employer.\53\ Relative to full diversification,\54\ employer
stock investments can be costly for DC plan participants.\55\ Other
lapses in diversification may involve omission from portfolios asset
classes such as overseas equity or debt, small cap stocks, or real
estate. Such lapses may sometimes reflect limited investment menus
supplied by DC plans.\56\ Yet even where adequate choices are available
and company stock is not a factor, investors sometimes fail to
diversify adequately.\57\ The Department believes that quality advice
will address over concentration in employer stock and other failures to
properly diversify.
---------------------------------------------------------------------------
\53\ See, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role
of Company Stock in Defined Contribution Plans, National Bureau of
Economic Research Working Paper W9250 (Oct. 2002); and Jeffrey R.
Brown & Scott Weisbenner, Individual Account Investment Options and
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social
Science Research Network Abstract 631886 (Dec. 2004).
\54\ This comparison should be viewed as an outer bound. Full
diversification of the same assets might not be feasible if
companies are unwilling to alter the compensation mix in this way
(see, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role of
Company Stock in Defined Contribution Plans, National Bureau of
Economic Research Working Paper W9250 (Oct. 2002)). The comparison
also neglects some potential tax benefits of employer stock
investments that might offset losses from reduced diversification
(see, e.g., Mukesh Bajaj et al., The NUA Benefit and Optimal
Investment in Company Stock in 401(k) Accounts, Social Science
Research Network Abstract 965808 (Feb. 2007)). See also, Lisa K.
Meulbroek, Company Stock in Pension Plans: How Costly Is It?, Social
Science Research Network Abstract 303782 (Mar. 2002) and Krishna
Ramaswamy, Company Stock and Pension Plan Diversification, in The
Pension Challenge: Risk Transfers and Retirement Income Security 71,
71- 88 (Olivia S. Mitchell & Kent Smetters eds., 2003). The economic
literature provides some evidence that investing in employer stock
increases participants' exposure to equity overall, which might
increase average wealth (see, e.g., Jack L. Vanderhei, The Role of
Company Stock in 401(k) Plans, Employee Benefit Research Institute
T-133 Written Statement for the House Education and Workforce
Committee, Subcommittee on Employer-Employee Relations, Hearing on
Enron and Beyond: Enhancing Worker Retirement Security (Feb. 2002),
at http://www.ebri.org/pdf/publications/testimony/t133.pdf).
\55\ Following findings reported in Lisa K. Meulbroek, Company
Stock in Pension Plans: How Costly Is It?, Social Science Research
Network Abstract 303782 (Mar. 2002), this estimate reflects losses
amounting to 14 percent of the employer stock's value, assuming 10
percent of DC plan assets are held in employer stock, the DC plan is
one-half of total wealth, and the holding period is 10 years. For
comparison, following findings reported in Krishna Ramaswamy,
Company Stock and Pension Plan Diversification, in The Pension
Challenge: Risk Transfers and Retirement Income Security 71, 71-88
(Olivia S. Mitchell & Kent Smetters eds., 2003), the annualized cost
of an option to receive the higher of the return on a typical
company stock or the return on a fully diversified equity portfolio
over a three-year horizon would amount to approximately $24 billion,
the Department estimates. This measure probably exaggerates the loss
to participants, however, insofar as it would preserve for the
participant the potential upside of a company stock that outperforms
the market.
\56\ See, e.g., Edwin J. Elton et al., The Adequacy of
Investment Choices Offered By 401(k) Plans, Social Science Research
Network Abstract 567122 (Mar. 2004), which finds that menus are
frequently inadequate, and Ning Tang and Olivia S. Mitchell, The
Efficiency of Pension Plan Investment Menus: Investment Choices in
Defined Contribution Pension Plans, University of Michigan
Retirement Research Center Working Paper WP 2008-176 (June 2008), at
http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp176.pdf,
which finds that most menus are efficient.
\57\ See, e.g., Laurent E. Calvet et al., Down or Out:
Assessing the Welfare Costs of Household Investment Mistakes,
Harvard Institute of Economic Research Discussion Paper No. 2107
(Feb. 2006).
---------------------------------------------------------------------------
Inappropriate Risk
Investors who avoid the foregoing mistakes might be said to invest
efficiently, in the sense that the investor generally can expect the
maximum possible return given their level risk. However, these
participants may still be making a costly mistake: they may fail to
calibrate the risk and return of their portfolio to match their own
risk and return preferences. As a result, participant investments may
be too risky or too safe for their own tastes. The Department currently
lacks a sufficient basis on which to estimate the magnitude of such
mistakes, but believes mistakes associated with inappropriate risk
levels may be common and large. The characteristics of a diversified
portfolio's risks and returns generally are determined by the
portfolio's allocation across asset classes. As noted above, there is
ample evidence that participants' asset allocation choices often are
inconsistent with fixed or well behaved risk and return preferences. If
participants' true preferences are in fact fixed or well behaved, then
observed asset allocations, which often appear to shift in response to
seemingly irrelevant factors (or fail to shift in response to relevant
factors), certainly entail large welfare losses. The Department
believes good advice might help participants calibrate their asset
allocations to match their true preferences.
Excess Taxes
It is likely that many households pay excess taxes as a result of
disconnects between their investments and current tax strategies.
Households saving for retirement must decide not only what assets to
hold, but also whether to locate these assets in taxable or tax-
deferred accounts. For example, households may be able to maximize
their expected after-tax wealth by first placing heavily taxed bonds in
their tax-deferred account and then placing lightly taxed equities in
their taxable account. However a significant number of households do
not follow this practice.\58\ What is not clear, however, is whether
such households are in fact making investment mistakes. In practice,
this simple asset location rule may fail to minimize taxes.\59\ As a
result the Department currently has no basis to estimate the magnitude
of excess taxes that might derive from participants' investment
mistakes. In any event, whether or to what extent investment advisers
would be positioned to provide advice on tax efficiency is unclear.
---------------------------------------------------------------------------
\58\ See, e.g., Daniel B. Bergstresser & James M. Poterba, Asset
Allocation and Asset Location: Household Evidence from the Survey of
Consumer Finances, Journal of Public Economics, Volume 88 1893,
1893-1915 (2004).
\59\ See, e.g., James M. Poterba et al., Asset Location for
Retirement Savers, in Public Policies and Private Pensions 290, 290-
331 (John B. Shoven et al. eds., 2004); John B. Shoven & Clemens
Sialm, Asset Location in Tax-Deferred and Conventional Savings
Accounts, Journal of Public Economics, Volume 88 (2003); James M.
Poterba et al., Asset Location for Retirement Savers, in Public
Policies and Private Pensions 290, 290-331 (John B. Shoven et al.
eds., 2004); Gene Amromin, Portfolio Allocation Choices in Taxable
and Tax-Deferred Accounts: An Empirical Analysis of Tax-Efficiency,
Social Science Research Network Abstract 302824 (May 2002); Lorenzo
Garlappi & Jennifer C. Huang, Are Stocks Desirable in Tax-Deferred
Accounts?, Journal of Public Economics, Volume 90 2257, 2257- and
Robert M. Dammon et al., Optimal Asset Location and Allocation with
Taxable and Tax-Deferred Investing, The Journal of Finance, Volume
LIX, Number 3 999, 999-1037 (2004).
---------------------------------------------------------------------------
Baseline Estimates: Availability and Use of Advice by Participants
Participants have always had the option of obtaining permissible
investment advice services directly in the retail market. DC plan
sponsors likewise have had the option of obtaining such services in the
commercial market and making them available to plan participants and
beneficiaries in connection with the plan.
Prior to the 2006 enactment of the PPA, a substantial fraction of
DC plan sponsors made investment advice available to plan participants
and beneficiaries. Today, as the PPA's implementation progresses, many
more have begun providing or are gearing up to provide such advice. The
Department bases its estimate for pre-PPA availability of advice to DC
plan participants on reported plan
[[Page 66155]]
experiences in 2006.\60\ The Department assumes that approximately 40
percent of DC plan sponsors provided access to investment advice either
on line, by phone, or in-person in 2006, as outlined in Table 3 below.
The Department further assumes that approximately 25 percent of the
participants that are offered advice use the offered advice, as
outlined in Table 4 below. In-person advice seems to be offered by most
plan sponsors. On-line advice and, to a lesser degree, telephone advice
are favored more by large sponsors. Smaller plan sponsors appear to
offer advice generally, and in-person advice in particular, more
frequently than larger plan sponsors.
---------------------------------------------------------------------------
\60\ This assessment is based on the Department's reading of
Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement,
2007 (2007); Profit Sharing/401(k) Council of America, 50th Annual
Survey of Profit Sharing and 401(k) Plans (2007); and Deloitte
Development LLC, Annual 401(k) Benchmarking Survey, 2005/2006
Edition (2006). In addition to investment advice, a majority of
sponsors also provide one or more other types of support to
participants' investment decisions.
Table 3--Availability of Advice: DC Plans Offering Advice
------------------------------------------------------------------------
Any advice
Policy context (computer
or live)
------------------------------------------------------------------------
Pre-PPA.................................................... 40%
PPA--Low Estimate.......................................... 56%
PPA--Primary Estimate...................................... 63%
PPA--High Estimate......................................... 69%
------------------------------------------------------------------------
Investment advice is also already used by a substantial fraction of
IRA participants, the Department believes. A majority of IRA
participants that invest in mutual funds purchase some or all of their
funds via a professional financial adviser.\61\ Overall in 2006, 60
percent of U.S. workers and retirees said they use the advice of a
financial professional when making retirement savings and investment
decisions; 40 percent said the advice of a financial professional was
more helpful to them than alternatives.\62\ However, what is not clear
from the survey was how recently the participant received the
referenced advice: in the same survey just 29 percent of participants
stated that in the past year they obtained investment advice from a
professional financial adviser who was paid through fees or
commissions.\63\
---------------------------------------------------------------------------
\61\ Eighty-two percent of mutual fund shareholders who hold
funds outside of DC plans purchase some or all of their funds from a
professional financial adviser such as a full-service broker,
independent financial planner, bank or savings institution
representative, insurance agent, or accountant (see, e.g., Victoria
Leonard-Chambers & Michael Bogdan, Why Do Mutual Fund Investors Use
Professional Financial Advisers?, Investment Company Institute
Research Fundamentals, Volume 16, Number 1 (April 2007)). As
families owning IRAs outnumber those owning pooled investment
vehicles outside of retirement accounts (see, e.g., Brian K. Bucks
et al., Recent Changes in U.S. Family Finances: Evidence from the
2001 and 2004 Survey of Consumer Finances, Federal Reserve Bulletin
92 A1, A1-A38 (2006)), it is reasonable to conclude that a large
majority of IRA beneficiaries who invest in mutual funds purchase
them via such professionals. However, the Department has no basis to
estimate the fraction of these beneficiaries that receive true
investment advice from such professionals. It is possible that some
make their purchase decisions without receiving any recommendation
or material guidance from the professional making the sale.
\62\ Alternatives including advice of peers, written plan
materials, print media, television and radio, seminars, software,
on-line information or advice, and retirement benefit statements
were all less likely to be characterized as ``most helpful.''
\63\ See, e.g., Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007).
Table 4--Use of Advice by DC Plan and IRA Participants
----------------------------------------------------------------------------------------------------------------
Share of participants advised
--------------------------------------------------
Policy context DC Plans
---------------------------------- IRA
Where offered Overall
----------------------------------------------------------------------------------------------------------------
Pre-PPA...................................................... 25% 10% 33%
PPA--Low Estimate............................................ 25% 14% 50%
PPA--Primary Estimate........................................ 25% 16% 67%
PPA--High Estimates.......................................... 25% 17% 80%
----------------------------------------------------------------------------------------------------------------
The effect of investment advice depends not merely on its
availability but on its use by DC plan and IRA participants. Do the
participants seek advice, and if so do they follow it? According to one
survey, among DC plan participants offered investment advice,
approximately one in four uses the offered advice. There is some
evidence that historically in-person advice has achieved higher use
rates than on-line advice, with on-line advice appealing more to
higher-income participants.\64\ In another survey large fractions of
workers say they would be very likely (19 percent) or somewhat likely
(35 percent) to take advantage of advice provided by the company that
manages their employer's DC plan. Of these, two-thirds said they would
implement only those recommendations that were in line with their own
ideas; 21 percent said they would implement all of the recommendations
they receive as long as they trusted the source.\65\ In a subsequent
survey, among those obtaining investment advice, 36 percent say they
implemented ``all'' of the advice, 58 percent ``some,'' and just 5
percent ``none.'' \66\
---------------------------------------------------------------------------
\64\ See, e.g., Profit Sharing/401(k) Council of America, 50th
Annual Survey of Profit Sharing and 401(k) Plans (2007); and Julie
Agnew, Personalized Retirement Advice and Managed Accounts: Who Uses
Them and How Does Advice Affect Behavior in 401(k) Plans?, Center
for Retirement Research Working Paper 2006-9 (2006).
\65\ See, e.g., Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007). In practice this might translate into a high rate of
compliance with recommendations, if recommendations turn out not to
diverge too much from participants' own ideas.
\66\ See, e.g., Employee Benefit Research Institute, 2008
Retirement Confidence Survey, Wave XVIII, Posted Questionnaire (Jan.
2008).
---------------------------------------------------------------------------
The Department's assumptions regarding use of advice are summarized
in Tables 3 and 4 above.\67\ The
[[Page 66156]]
Department believes it is likely that in practice a large proportion of
participants who receive advice will follow that advice either in whole
or in part. This is especially likely if the advice turns out to be
broadly in line with the participants' own thinking. Nonetheless, some
advice will not be followed, and as a result some investment errors
will not be corrected. For purposes of this analysis, the Department
has assumed that advised participants make investment errors at one-
half the rate of unadvised participants. The remaining errors reflect
participant failures to follow advice. Additionally, for purposes of
this analysis, the Department assumes that all permissible advice
arrangements deliver advice of similar quality and effectiveness.
---------------------------------------------------------------------------
\67\ The Department's bases its assumptions on its reading of
Employee Benefit Research Institute, 2007 Retirement Confidence
Survey, Wave XVII, Posted Questionnaire (Jan. 2007); Hewitt
Associates LLC, Survey Findings: Hot Topics in Retirement, 2007
(2007); Profit Sharing/401(k) Council of America, 50th Annual Survey
of Profit Sharing and 401(k) Plans (2007); and Deloitte Development
LLC, Annual 401(k) Benchmarking Survey, 2005/2006 Edition (2006).
There are a number of reasons to believe that use of advice will be
higher among IRA beneficiaries than DC plan participants. The
aforementioned survey reports, read together, generally support this
conclusion. In addition, relative to IRA beneficiaries, DC
participants may have less need for advice and/or easier access to
alternative forms of support for their investment decisions. DC plan
participants' choice is usually confined to a limited menu selected
by a plan fiduciary, and the menu may include one-stop alternatives
such as target date funds that may mitigate the need for advice.
Their plan or employer may provide general financial and investment
education in the form of printed material or seminars. They often
make initial investment decisions (sometimes by default) before
contributing to the plan so the decisions' impact may seem small.
Finally, the availability of advice in connection with the plan is
intermediated by the plan sponsor and fiduciary. In contrast, IRA
beneficiaries generally have wider choice and are more likely to be
without employer-provided support for their decisions. Decision
points may more often occur when account balances are large, such as
when rolling a large DC plan balance into an IRA or when retiring.
Finally, the availability of advice to IRA beneficiaries is not
intermediated by an employer--rather IRA beneficiaries interface
directly with the retail market and will thereby be more directly
affected by the exemptive relief provided by the PPA and this final
regulation. For all of these reasons IRA beneficiaries may use
advice more frequently than DC plan participants.
Table 5--Number of Entities
------------------------------------------------------------------------
PPA
--------------------------------
Pre-PPA Low Primary High
estimate estimate estimate
------------------------------------------------------------------------
DC:
Plans offering (000s)... 238 335 372 410
Participants offered 30 42 46 51
(MM)...................
Participants using (MM). 6 9 10 11
-------------------------------------------
IRA:
IRAs using (MM)......... 17 25 34 41
------------------------------------------------------------------------
Impact--Benefit
For purposes of this assessment, the Department estimates that as a
result of the PPA and this final regulation the proportion of
participants using advice will increase.\68\ As stated above, the
Department has assumed that advised participants make investment errors
at one-half the rate of unadvised participants. The estimates provided
in the Tables 3 to 5 show three possible impacts for the PPA and this
final regulation to reflect the uncertainty surrounding the
availability and use of advice as well as the percentage of errors
eliminated by advice: ``low'' estimates assume that 14 percent of DC
plan participants and half of IRA beneficiaries will utilize advice
which eliminates 25 percent of investment errors, ``primary'' estimates
assume that 16 percent of DC plan participants and two-thirds of IRA
beneficiaries will utilize advice which eliminates half of investment
errors, and ``high'' estimates assume that 17 percent of DC plan
participants and 80 percent of IRA beneficiaries will utilize advice
which eliminates 75 percent of investment errors.
---------------------------------------------------------------------------
\68\ See 74 FR No 164 (Aug. 22, 2008), 74 FR No 12 (Jan. 21,
2009), and 75 FR No 40 (Mar. 2, 2010) for background on the analysis
contained in the Department's Regulatory Impact Analysis.
---------------------------------------------------------------------------
As summarized in Tables 3 through 5 above, the PPA and this final
regulation will increase the availability of investment advice and
thereby increase the use of investment advice by participants. The PPA
and this final regulation will reduce investment mistakes by between $7
billion and $18 billion annually, the Department estimates.
Cumulatively, after implementation of this final regulation, use of
existing and new investment advice by DC plan and IRA participants will
eliminate between $22 billion and $33 billion worth of investment
errors annually. The Department's estimates of investment errors and
reductions from investment advice are summarized in Table 2 above.
Costs
Compliance with the terms and condition of the final rule is a
condition of relief from the prohibited transaction provisions of ERISA
and the Code. Such exemptive relief would allow a fiduciary adviser to
receive compensation from providers of recommended investments. As
such, this final rule does not include any Federal mandates that will
require expenditures by the private sector per se. Plan sponsors and
participants are expected to take advantage of these new opportunities
in the marketplace; therefore these plans and participants will
shoulder the costs to reap the associated benefits.
Nevertheless, participant gains from investment advice must be
weighed against the cost of that advice. This final rule is expected to
make quality fiduciary advice available to participants at a lower
direct price, because advisers will be able to rely on indirect revenue
sources, subject to the safeguards and conditions of the final rule, to
compensate their efforts. It may also make such advice available at a
lower total cost to participants.
The general prohibition against transactions wherein fiduciary
advisers' and participants' interests may conflict carries costs. Faced
with such bars advisers may forgo certain potential economies of scale
in production and distribution of financial services that would derive
from more vertical and horizontal integration.\69\ If they choose
instead to take advantage of these opportunities and relationships,
they must incur costs to carefully monitor and calibrate their
relationships and compensation arrangements to avoid a prohibited
fiduciary conflict, or structure and monitor their arrangements to meet
the conditions of an applicable prohibited transaction exemption.
---------------------------------------------------------------------------
\69\ For example, an adviser employed by an asset manager can
share the manager's research instead of buying or producing such
research independently.
---------------------------------------------------------------------------
On the other hand, absent adequate protections, conflicts
themselves may be more costly to participants than a general
prohibition against them. The safeguards and conditions included in
this final regulation are calibrated to ensure that conflicts do not
compromise the quality of fiduciary advice.
The Department therefore expects this final rule to produce cost
savings by harnessing economies of scale and by reducing compliance
burdens. The Department is unaware of any available empirical basis on
which to determine
[[Page 66157]]
whether or by how much costs might be reduced, however.
Different types of advice may come with different costs. For
example, advice generated by an automated computer program may be less
costly than advice provided by a personal adviser. For purposes of this
analysis the Department assumed that in the context of a DC plan,
computer generated advice costs 10 basis points annually, while adviser
provided advice costs 20 basis points. In connection with an IRA the
corresponding assumptions are 15 and 30 basis points. These assumptions
are reasonable in light of information available to the Department
about the cost of various existing advice arrangements. On this basis
the Department estimates the aggregate cost of advice under the final
rule to be a range between $1.9 billion and $5.1 billion annually as
summarized in Table 6 below. These costs include the costs, outlined in
the Paperwork Reduction Act section below, associated with requirements
to document and keep records, provide disclosures to participants, hire
an independent auditor, and obtain certification of the model from an
eligible investment expert.
Table 6--Cost of Advice
------------------------------------------------------------------------
PPA
--------------------------------
Pre-PPA Low Mid High
estimate estimate estimate
------------------------------------------------------------------------
Incremental:
Advice cost ($billions). $3.90 $1.90 $3.70 $5.10
Advice cost rate (bps, 22.4 22.6 23.0 23.1
average)...............
-------------------------------------------
Cumulative (combined with
policies to the left):
Advice cost ($billions). 3.90 5.80 7.60 9.00
Advice cost rate (bps, 22.4 22.4 22.7 22.8
average)...............
------------------------------------------------------------------------
Regulatory Alternatives
Executive Order 12866 requires an economically significant
regulation to include an assessment of the costs and benefits of
potentially effective and reasonably feasible alternatives to a planned
regulation, and an explanation of why the planned regulatory action is
preferable to the identified potential alternatives. In formulating
this final regulation, the Department considered several alternative
approaches regarding computer model design and operation, which are
discussed below. For a more detailed discussion of these alternatives,
see section B.2., above.
Paragraph (b)(4)(i)(A) of the March 2010 proposal requires a
computer model to be designed and operated to apply generally accepted
investment theories that take into account historical risks and returns
of different asset class over defined periods of time. The Department
solicited comments in the proposal regarding whether the Department
should amend the rule to specify generally accepted investment theories
and require their application or specify certain practices required by
such theories. Most commenters indicated that they did not believe the
Department should specifically define or identify generally accepted
investment theories or prescribe particular practices or computer model
parameters. They explained that economic and investment theories and
practices continually evolve over time in response to changes and
developments in academic and expert thinking, technology, and financial
markets. Some commenters explained that additional specificity would
facilitate compliance determinations. Other commenters described
theories and practices they believed to be generally accepted.
After carefully considering the comments, the Department decided
not to change the provision in the final rule. The Department is
concerned that attempting to provide additional specificity in this
area, such as by prescribing an acceptable list of theories and
practices, may result in significant unintended consequences. Specific
requirements might limit advisers' ability to select or apply the most
current or effective investment theories, and thereby impede beneficial
innovations in investment advice and reduce the economic benefits of
the statutory exemption. The Department also believes that the final
rule's computer model requirements, taken together, are sufficient to
safeguard against application of investment theories that are not
generally accepted.
Paragraph (b)(4)(i)(F)(1) of the March 2010 proposal requires a
computer model to take into account all ``designated investment
options'' available under the plan without giving inappropriate weight
to any investment option. The term ``designated investment option'' is
defined to mean any investment option designated by the plan into which
participants and beneficiaries may direct the investment of assets held
in, or contributed to, their individual accounts. The term ``designated
investment option'' does not include ``brokerage windows,'' ``self-
directed brokerage accounts,'' or similar plan arrangements that enable
participants and beneficiaries to select investments beyond those
designated by the plan.
Under paragraph (b)(4)(i)(F)(2) of the proposal, a computer does
not have to make recommendations relating to the acquisition, holding
or sale of the following: qualifying employer securities; an investment
that allocates the invested assets of a participant or beneficiary to
achieve varying degrees of long-term appreciation and capital
preservation through equity and fixed income exposures, based on a
defined time horizon or level of risk of the participant or
beneficiary; and an annuity option with respect to which a participant
or beneficiary may allocate assets toward the purchase of a stream of
retirement income payments guaranteed by an insurance company.
The Department considered retaining this provision in the
corresponding provision of the final rule, paragraph (b)(4)(i)(G).
However, the Department has decided to remove qualifying employer
securities and asset allocations funds from the list of excepted
options. Based on comments received in response to the proposal, the
Department believes that it is feasible to develop a computer model
capable of addressing investments in qualifying employer securities,
and that plan participants will significantly benefit from this advice.
For example, DC plan participants sometimes concentrate their assets
excessively in stock of their
[[Page 66158]]
employer.\70\ Participant investments in employer securities can
undermine diversification and thereby cause participants to bear
uncompensated risk. This uncompensated risk comes at a cost.\71\
According to 2008 Department estimates, holding employer stock instead
of a diversified portfolio of investments cost DC plan participants $3
billion in risk-adjusted value annually.\72\ Yet, participants often
seem unaware of this uncompensated risk and falsely believe that they
can gauge how their company stock will perform in the future.\73\ Good
investment advice can benefit participants by promoting appropriate
diversification \74\ and combat some of the false perceptions of
participants concerning employer stock.\75\
---------------------------------------------------------------------------
\70\ Mitchell, Olivia S., and Stephen P. Utkus. October 2002.
``The Role of Company Stock in Defined Contribution Plans.'' NBER
Working Paper No. W9250. Citing EBRI/ICI data, the authors find
that, of those participants who are offered company stock through
their 401(k), 48 percent of them hold over 20 percent of their
401(k) assets in company stock and approximately one third of them
hold over 40 percent of their 401(k) assets in company stock. The
authors acknowledge that there are potential productivity gains
attributable to employee stock ownership. However, diversifying
assets, on average, decreases wealth volatility. While not
explicitly pointed out in this article, the volatility argument is
particularly relevant when a participant holds a high concentration
of one's own company stock because company financial distress will
correspond directly with both lower job security and decreased
financial returns.
\71\ Meulbroek, Lisa. 2002. ``Company Stock in Pension Plans:
How Costly is it?'' Harvard Business School Working Paper 02-058.
\72\ This figure is based upon an estimate from Meulbroek (2002)
where if 10 percent of DC plan assets are held in employer stock,
the DC plan is one-half total wealth, and the holding period is 10
years, investors lose out on 14 percent of risk-adjusted value.
\73\ Benartzi, Shlomo and Richard Thaler. 2007. ``Heuristics and
Biases in Retirement Savings Behavior'' The Journal of Economic
Perspectives, Vol. 21, Summer, pp. 81-104. Citing a Boston Research
Group (2002) study of individuals (most of whom were highly aware of
the Enron scandal), half of the respondents said their company stock
carries less risk than a money market fund. Another study, that
included the coauthors, found that only 33 percent of the
respondents who own company stock realize that it is riskier than a
``diversified fund with many stocks.'' Employees' investment
decisions reflect a belief that strong past performance by their
company means that they should invest more in employee stock. Yet,
this seems to have little bearing on future performance.
\74\ Mottola, Gary and Stephen Utkus. 2007. ``Red, Yellow, and
Green: A Taxonomy of 401(k) Choices'' Pension Research Council
Working Paper, PRC WP 2007-14. Examining Vanguard's database of 2.9
million participants, the authors found that 17.2 percent of
participants had invested more than 20 percent of their assets in
company stock. A subset of 12,000 participants adopted managed
account services. The authors were able to compare this subset's
behavior before and after adopting the services. Before adoption, 11
percent of the participants had over 20 percent of their portfolio
in company stock; a year after adoption, only 2 percent of the
participants did.
\75\ Choi, James, David Laibson, and Brigitte Madrian. 2005.
Brookings Papers on Economic Activity, Vol. 2005, No. 2, pp. 151-
198. Participants view the offering of the employee stock as a
recommendation to purchase the stock. Loyalty to one's company may
also be a factor.
---------------------------------------------------------------------------
The Department also decided to remove asset allocation funds from
the list of excepted options. Asset allocation funds generally are
designed to maintain a particular asset allocation that takes into
account the time horizon or risk tolerance of the participant. Some
commenters to the Department's 2008 proposed rule opined that it served
no purpose to include such funds in an investment advice model's
unrelated, overlaying asset allocation analysis. However, the
Department's subsequent consideration of asset allocation funds has
demonstrated that: (1) The asset allocation and associated risk and
return characteristics of different funds targeted at similar
participants varies widely; (2) the risk and return preferences of
participants vary widely with factors other than the time horizons that
are the sole targeting factor for many asset allocation funds; (3)
participants investing in asset allocation funds sometimes do not
understand the funds' risk and return characteristics; and (4) as a
result of the forgoing, the risk and return characteristics of the
asset allocation funds participants invest in are sometimes poorly
aligned with the participants' own risk and return preferences. Because
investment advice models will take into account designated investment
options' true risk and return characteristics as well as participant
characteristics and circumstances beyond time horizons, the Department
believes that participants will benefit from investment advice that
considers any asset allocation funds that are available to them.
The Department notes that a provision added to the final rule,
paragraph (b)(4)(i)(G)(2)(ii), provides that a computer model will not
fail to satisfy the requirements of paragraph (b)(4)(i)(G)(1) merely
because it does not provide a recommendation with respect to an
investment option that a participant or beneficiary requests to be
excluded from consideration in such recommendations. Therefore,
participants may express a preference for asset allocation funds to be
excluded from a recommendation. This would be relevant in situations
where participants do not want to include asset allocation funds in
computer model investment advice, because such products themselves rely
on a fund manager to maintain a particular asset allocation taking into
account their time horizons (retirement age, life expectancy) and risk
tolerance.
The Department, however, has decided to retain the exception for
in-plan annuity products. It might be challenging for a computer model
that is designed to select the optimal asset allocation for a
participant's investments to also incorporate an option about whether
the participant should purchase an in-plan annuity and how much of the
portfolio should be dedicated to such a product. Annuities differ from
other investments across several dimensions. For example, one valuable
benefit to a lifetime annuity is that it provides an insurance-like
feature of a guaranteed income stream that will last as long as one
lives. It is difficult to know, however, how that should be valued
within the context of a computer model. Similarly, participants'
preferences about annuities may vary depending on their preferences
regarding bequests. Another factor participants must consider is that
the annuity may lock them in, either by preventing them from pulling
out their accumulated value and investing it elsewhere or by imposing a
penalty for doing so. Typically other investment options offer more
liquidity. All of these features of annuities mean that it might be
difficult to design a computer model that could produce a
recommendation for a participant regarding the optimal selection of
assets and purchase of annuities.
As an additional approach to ensuring that investment advice is not
tainted by conflicts of interest, paragraph (b)(4)(i)(E)(3) of the
March 2010 proposal provides that a computer model must be designed and
operated to avoid investment recommendations that inappropriately
distinguish among investment options in a single asset class on the
basis of a factor that cannot confidently be expected to persist in the
future.
A number of commenters requested that the Department remove
paragraph (b)(4)(i)(E)(3). Some opined that the test contained in that
provision--which applies on an asset-class by asset-class basis--lacks
sufficient clarity because it fails to define the essential term
``asset class''. Some commenters also requested removal of this
provision unless the Department clarifies that it would be acceptable
for a computer model to take into account historical performance data.
According to these commenters, the proposal's discussion of paragraph
(b)(4)(i)(E)(3) and related computer model questions has been construed
as strictly prohibiting, or strongly cautioning against, any
consideration of historical performance data, even if
[[Page 66159]]
considered in conjunction with other information. These commenters
opined that a complete disregard of historical performance data would
be inconsistent with generally accepted investment theories.
Additionally, some cautioned that, by limiting consideration to
only those factors that can confidently be expected to persist in the
future, a computer model might be limited to distinguishing between
investment options solely on the basis of fees and expenses. A
commenter noted that, other than fees, it could not identify any other
factor with the necessary likelihood of persistence required under the
proposal. Although commenters generally agreed that fees are an
important consideration, most recognized they should not be the only
factor taken into account.
---------------------------------------------------------------------------
\76\ See e.g., Russ Wermers, ``Mutual Fund Performance: An
Empirical Decomposition Into Stock-Picking Talent, Style,
Transaction Costs And Expenses,'' The Journal of Finance (Aug.,
2000). This study finds that fund managers choose stocks that
outperform their relevant benchmark by an average of 71 basis points
per year. However, non-stock components, expense ratios, and
transaction costs explain why the returns on these active funds are
not as high on average as index funds.
\77\ See e.g., Eugene Fama and Kenneth French, ``Luck Versus
Skill in the Cross Section of Mutual Fund Returns,'' Journal of
Finance (Sept. 21, 2010), at http://www.afajof.org/afa/forthcoming/6311.pdf. This study finds that approximately 10 percent of managers
demonstrate higher returns before fees than what random chance would
generate. Yet, after fees are taken into account, this share
declines to 1 percent.
See also Robert Kosowski, Allan Timmermann, Russ Wermers and Hal
White, ``Can Mutual Fund `Stars' Really Pick Stocks? New Evidence
from a Bootstrap Analysis,'' The Journal of Finance, Volume LXI,
Number 6 (Dec. 2006). The authors find a larger share of fund
managers demonstrating significant skill. Fama and French believe
this analysis suffers from some of the same selection biases that
industry prospectuses do.
See also John Hughes, Jing Liu and Mingshan Zhang,
``Overconfidence, Under-Reaction, and Warren Buffett's
Investments,'' at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1635061. This study finds that mimicking Warren Buffett's
position, or that of other top performing investment managers, can
generate additional returns. The fact that following another fund's
lead can be a credible exercise may be an argument in favor of
looking at prior returns of some funds. However, the fact that
winning strategies do get mimicked is an argument made by some that
success cannot be indefinitely sustained. Copycats potentially drive
up the price of the underlying assets over time.
See e.g., Jonathan B. Berk, and Richard C. Green, ``Mutual Fund
Flows and Performance in Rational Markets,'' Journal of Political
Economy, Volume 112, pp. 1269-1295 (2004).
---------------------------------------------------------------------------
A number of commenters expressed concern that this provision of the
proposal, with its focus on historical performance data, superior past
performance and fees, appeared to suggest that it would be
impermissible under any circumstances for a plan fiduciary to pursue an
active management style, or that a plan fiduciary would bear a very
high burden of justification. Commenters also stated that the
Department's proposal appeared to demonstrate a clear bias in favor of
passive investment styles over active styles, which they believe to be
premature because it is the subject of ongoing debate among investment
experts.
Other commenters, however, questioned the utility of historical
performance data beyond estimating future performance of an entire
asset class. They further noted that, because the regulation permits a
fiduciary adviser to provide investment recommendations to plan
participants when the adviser has an interest in the investment options
being recommended, there is the potential that the computer model might
be designed to favor certain options by giving undue weight to
historical performance data. They therefore stressed the importance of
scrutinizing the use of historical performance data and supported the
inclusion of paragraph (b)(4)(i)(E)(3).
As discussed above, the provision is not intended to prohibit a
computer model from any consideration of an investment option's
historical performance, as some commenters interpreted. Based on its
review of relevant academic literature, the Department does not believe
such a prohibition is warranted. Although the academic literature
indicates that there is skill in the investment community,\76\ there is
considerable disagreement amongst academics as to how much persistent
skill fund managers exhibit.\77\
Without further clarification, a fiduciary adviser might not
consider any factors whose persistence is in doubt, such as historical
performance, but instead would consider only factors that are
essentially fixed, such as fees and expenses, solely because she is
unwilling to risk noncompliance with that provision. That is, fiduciary
advisers might omit from consideration factors that would be beneficial
to consider, even when there is a sound empirical basis to justify
their consideration. The Department believes that the final rule should
not discourage consideration of factors whose predictive properties can
be demonstrated. Accordingly, the Department has clarified application
of this provision at paragraph (b)(4)(i)(C).
Uncertainty
The Department is highly confident in its conclusion that
investment errors are common and often large, producing large avoidable
losses (including foregone earnings) for participants. It is also
confident that participants can reduce errors substantially by
obtaining and following good advice. While the precise magnitude of the
errors and potential reductions therein are uncertain, there is ample
evidence that that magnitude is large.
However, the Department is uncertain to what extent advice will
reach participants and to what extent advice that does reach them will
reduce errors. To illustrate that uncertainty, the Department conducted
sensitivity tests of how its estimates of the reduction in investment
errors attributable to the PPA and this final rule would change in
response to alternative assumptions regarding the availability, use,
and quality of advice. Table 7 the results of these tests.\78\
---------------------------------------------------------------------------
\78\ The Department maintains the 2006 baseline numbers used in
the 2008 Proposal (73 FR 49896 (Aug. 22, 2008), at http://webapps.dol.gov/FederalRegister/HtmlDisplay.aspx?DocId=21243&AgencyId=8&DocumentType=1). The
baseline assessment was based on the Department's reading of Hewitt
Associates LLC, Survey Findings: Hot Topics in Retirement, 2007
(2007), at http://www.hewittassociates.com/Lib/MBUtil/AssetRetrieval.aspx?guid=CE3EEF86-50E7-4EEC-8C32-82FD055690A6;
Profit Sharing/401(k) Council of America, 50th Annual Survey of
Profit Sharing and 401(k) Plans (2007); and Deloitte Development
LLC, Annual 401(k) Benchmarking Survey, 2005/2006 Edition (2006), at
http://www.google.com/url?sa=t&source=web&cd=5&ved=0CDUQFjAE&url=http%3A%2F%2Fwww.ifebp.org%2Fpdf%2Fresearch%2F2005-06Annual401kSurvey.pdf&ei=_76UTYSXMY6y0QHBjZmADA&usg=AFQjCNFsUmmwPpFA_EoBDUGyB9uypfFCCQ.
Table 7--Uncertainty in Estimate of Investment Error Reduction
----------------------------------------------------------------------------------------------------------------
After PPA/Final Rule: Impact of
----------------------------------------------------------------------------- Impact of all Remaining
Advice eliminates: Advice reaches: PPA advice errors
----------------------------------------------------------------------------------------------------------------
25% of errors............................ 14% of DC and 50% of IRA......... $7 $21 $107
50% of errors *.......................... 16% of DC and 67% of IRA*........ 13 28 101
[[Page 66160]]
75% of errors............................ 17% of DC and 80% of IRA......... 18 33 96
----------------------------------------------------------------------------------------------------------------
Note: Primary estimates denoted.*
The Department is uncertain about the mix of advice and other
support arrangements that will compose the market, and about the
relative effectiveness of alternative investment advice arrangements or
other means of supporting participants' investment decisions. For
example, to what extent will arrangements pursuant to this final rule
displace alternative arrangements? Will advice arrangements operating
pursuant to this final rule be more, less, or equally effective as
alternative arrangements?
This analysis has assumed that all types of permissible advice
arrangements are equally effective at reducing investment errors, and
that none will increase errors (there will be no very bad advice). This
assumption may not hold, however. The Department notes that if users of
advice are fully informed and rational then more cost effective
arrangements will dominate the market. This final rule establishes
conditions to ensure that prospective users of advice available
pursuant to it will have the opportunity to become fully informed.
The Department is uncertain about the potential magnitude of any
transitional costs associated with this final rule. These might include
costs associated with efforts of prospective fiduciary advisers to
adapt their business practices to the applicable conditions. They might
also include transaction costs associated with initial implementation
of investment recommendations by newly advised participants.
Another source of uncertainty involves potential indirect
downstream effects of this final rule. Investment advice may sometimes
come packaged with broader financial advice, which may include advice
on how much to contribute to a DC plan. The Department currently has no
basis to estimate the incidence of such broad advice or its effects,
but notes that those effects could be large. The opening of large new
markets to a variety of investment advice arrangements to which they
were heretofore closed may affect the evolution of investment advice
products and services and related technologies and their distribution
channels and respective market shares. Other possible indirect effects
that the Department currently lacks bases to estimate include financial
market impacts of changes in investor behavior and related
macroeconomic effects.
Regulatory Flexibility Act
The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes
certain requirements with respect to Federal rules that are subject to
the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551 et seq.) and are likely to
have a significant economic impact on a substantial number of small
entities. For purposes of analysis under the RFA, the Department
proposes to continue its usual practice of considering a small entity
to be an employee benefit plan with fewer than 100 participants.\79\
The Department estimates that approximately 100,000 small plans, a
significant number, will voluntarily begin offering investment advice
to participants as a result of this final regulation.
---------------------------------------------------------------------------
\79\ EBSA has consulted with the SBA Office of Advocacy
concerning use of this participant count standard for RFA purposes.
See 13 CFR 121.903(c).
---------------------------------------------------------------------------
The primary effect of this final regulation will be to reduce
participants' investment errors. This is an effect on participants
rather than on plans. The impact on plans generally will be limited to
increasing the means by which they may make advice available to
participants, and this impact will be similar and proportionate for
small and large plans. Therefore the Department certifies that the
impact on small entities will not be significant. Pursuant to this
certification the Department has refrained from preparing an Initial
Regulatory Flexibility Analysis of this final regulation.
Notwithstanding this certification, the Department did separately
consider the impact of this final regulation on participants in small
plans.
As noted above, prior to implementation of the PPA smaller plan
sponsors offered advice generally, and in-person advice in particular,
more frequently than larger plan sponsors. The Department believes that
exemptive relief provided by both the PPA and this final regulation
will promote wider offering of advice by small and large plans sponsors
alike. Accordingly the Department estimated the impacts on small plans
assuming that they generally will be proportionate to those on large
plans. However, because smaller plan sponsors are more likely to offer
in-person advice, their average cost for advice and the proportion of
participants using advice may both be higher. The Department estimates
that the PPA and this final regulation will reduce small DC plan
participant investment errors respectively by between $169 million and
$299 million annually, at a cost of between $38 million and $67 million
annually. The estimated impacts on small plans and their participants
are summarized in Table 8 below.
Table 8--Small DC Plan Participant Impacts
------------------------------------------------------------------------
PPA
--------------------------------
Pre-PPA Low Primary High
estimate estimate estimate
------------------------------------------------------------------------
Dollars advised ($billions). $50 $71 $79 $87
Investment errors $7.9 $7.7 $7.7 $7.6
($billions)................
-------------------------------------------
[[Page 66161]]
Incremental:
Errors reduced by advice $416 $169 $234 $299
($millions)............
Advice cost ($millions). $93 $38 $52 $67
Advice cost rate (bps, 18 18 18 18
average)...............
Error reduced per $1 of $4.49 $4.49 $4.49 $4.49
advice, average........
-------------------------------------------
Cumulative (combined with
policies to the left):
Errors reduced by advice $416 $585 $650 $715
($millions)............
Advice cost ($millions). $93 $130 $145 $159
Advice cost rate (bps, 18 18 18 18
average)...............
Error reduced per $1 of $4.49 $4.49 $4.49 $4.49
advice, average........
------------------------------------------------------------------------
Congressional Review Act
This final rule is subject to the Congressional Review Act
provisions of the Small Business Regulatory Enforcement Fairness Act of
1996 (5 U.S.C. 801 et seq.) and will be transmitted to the Congress and
the Comptroller General for review.
Unfunded Mandates Reform Act
For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L.
104-4), as well as Executive Order 12875, the final rule does not
include any Federal mandate that will result in expenditures by state,
local, or tribal governments in the aggregate of more than $100
million, adjusted for inflation, or increase expenditures by the
private sector of more than $100 million, adjusted for inflation.
Compliance with the terms and condition of the final rule is a
condition of relief from the prohibited transaction provisions of ERISA
and the Code. Such exemptive relief would allow a fiduciary adviser to
receive compensation from providers of recommended investments. As
such, this final rule does not include any Federal mandates that will
require expenditures by the private sector per se.
Federalism Statement
Executive Order 13132 (August 4, 1999) outlines fundamental
principles of federalism and requires the adherence to specific
criteria by federal agencies in the process of their formulation and
implementation of policies that have substantial direct effects on the
States, the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government. This final rule does not have federalism
implications because it has no substantial direct effect on the States,
on the relationship between the national government and the States, or
on the distribution of power and responsibilities among the various
levels of government. Section 514 of ERISA provides, with certain
exceptions specifically enumerated, that the provisions of Titles I and
IV of ERISA supersede any and all laws of the States as they relate to
any employee benefit plan covered under ERISA. The requirements
implemented in the rule do not alter the fundamental provisions of the
statute with respect to employee benefit plans, and as such would have
no implications for the States or the relationship or distribution of
power between the national government and the States.
Paperwork Reduction Act
In accordance with the requirements of the Paperwork Reduction Act
of 1995 (PRA) (44 U.S.C. 3506(c)(2)), the notice of proposed rulemaking
(NPRM) solicited comments on the information collections included
therein. The Department also submitted an information collection
request (ICR) to OMB in accordance with 44 U.S.C. 3507(d),
contemporaneously with the publication of the NPRM, for OMB's review.
Although no public comments were received that specifically addressed
the paperwork burden associated with the ICR, the Department welcomes
public comments on its estimates and any suggestions for reducing the
paperwork burdens.
In connection with the publication of this final rule, the
Department submitted an ICR to OMB for a revised information
collection. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid OMB control number. OMB approved the ICR on October
18, 2011 under OMB Control Number 1210-0134, which will expire on
October 31, 2014. A copy of the ICR may be obtained by contacting the
PRA addressee: G. Christopher Cosby, Office of Policy and Research,
U.S. Department of Labor, Employee Benefits Security Administration,
200 Constitution Avenue, NW., Room N-5718, Washington, DC 20210.
Telephone: (202) 693-8410; Fax: (202) 219-2745. These are not toll-free
numbers. E-mail: [email protected]. ICRs submitted to OMB also are
available at reginfo.gov (http://www.reginfo.gov/public/do/PRAMain).
In order to use the statutory exemption to provide investment
advice to participants, fiduciary advisers are required to make
disclosures to participants, authorizing fiduciaries, and hire an
independent auditor to conduct a compliance audit and issue an audit
report every year. Fiduciary advisers who satisfy the conditions of the
exemption based on the provision of computer model-generated investment
advice are required to obtain certification of the model from an
eligible investment expert. These paperwork requirements are designed
to safeguard the interests of participants in connection with
investment advice covered by the rule.
The Department calculated the estimated hour and cost burden of the
ICRs under the final rule using the same methodology that was used in
making such estimate in the March 2010 proposal.\80\ The Department has
made a minor increase to the estimated number of DC plan sponsors
offering advice, the number of DC plan participants utilizing advice,
and the labor hour rates used to estimate the hour burden based on more
[[Page 66162]]
current data.\81\ The Department also has taken into account a new
requirement in paragraph (b)(8) of the final rule, which requires
fiduciary advisers to provide written notification to authorizing
fiduciaries stating that it: (i) Intends to comply with the conditions
of the statutory exemption under ERISA sections 408(b)(14) and 408(g)
and these final regulations; (ii) will be audited annually by an
independent auditor for compliance with the conditions of the exemption
and regulations; and, (iii) that the auditor will furnish the
authorizing fiduciary with a copy of the auditor's findings within 60
days of completion of the audit.\82\ All other calculations remain the
same as in the March 2010 proposed rule.
---------------------------------------------------------------------------
\80\ 75 FR 9360, 9364-65 (Mar. 2, 2010), at http://webapps.dol.gov/FederalRegister/HtmlDisplay.aspx?DocId=23559&AgencyId=8&DocumentType=1.
\81\ The increase in the estimated number of DC plans offering
advice and DC plan participants utilizing advice is due to updating
the count to reflect 2008 Form 5500 data, the latest year for which
Form 5500 data is available. The counts in the 2010 Proposed Rule
were based on 2006 Form 5500 data.
\82\ The Department estimates that no additional hour or cost
burden will be associated with this disclosure, because it will be
provided in the normal course of engaging in an eligible investment
advice engagement.
---------------------------------------------------------------------------
The Department made several specific basic assumptions in order to
establish a reasonable estimate of the paperwork burden of this
information collection:
The Department assumes that 80% of disclosures \83\ will
be distributed electronically via means already in existence as a usual
and customary business practice and the costs arising from electronic
distribution will be negligible.
---------------------------------------------------------------------------
\83\ This estimate is derived from Current Population Survey
October 2003 School Supplement probit equations applied to the
February 2005 Contingent Worker Supplement. These equations show
that approximately 81 percent of workers aged 19 to 65 had internet
access either at home or at work in 2005. The Department further
assumes that one percent of these participants will elect to receive
paper documents instead of electronic, thus 20 percent of
participants receive disclosures through paper media.
---------------------------------------------------------------------------
The Department assumes that investment advisory firms will
use existing in-house resources to prepare most disclosures and to
maintain the recordkeeping systems. This assumption does not apply to
the computer model certification, the audit or the computer program
used to generate disclosures for IRA participants.
The Department assumes a combination of personnel will
perform the information collections with an hourly wage rate for 2011
of approximately $111, including both wages and benefits, for a
financial manager and approximately $27 for clerical personnel.\84\
Legal professional time is similarly assumed to be almost $124 per
hour, and computer programming time is estimated at $72 per hour.
---------------------------------------------------------------------------
\84\ Hourly wage estimates are based on data from the Bureau of
Labor Statistics Occupational Employment Survey (May 2009) and the
Bureau of Labor Statistics Employment Cost Index (October 2010).
Clerical wage and benefits estimates are based on metropolitan wage
rates for executive secretaries and administrative assistants.
Financial manager wage and benefits estimates are based on
metropolitan wage estimates for financial managers. Legal
professional wage and benefits estimates are based on metropolitan
wage rates for lawyers. Computer programmer wage and benefits
estimates are based on metropolitan wage rates for professional
computer programmers.
---------------------------------------------------------------------------
The Department assigned an hour burden (with associated `equivalent
costs' derived from multiplying the hour burden by the estimated
employee compensation) and a cost burden (the actual monetary expenses
of the entity, i.e. material and postage costs and fees paid to outside
entities) to this final regulation. The total costs of this final
regulation are calculated by adding the mutually exclusive hour burden
equivalent costs and the cost burden. These PRA costs are a subset of
the overall costs of this final regulation. The Department estimates
that the third-party disclosures, computer model certification, and
audit requirements for the final statutory exemption will require
approximately 5.2 million burden hours (with an associated equivalent
cost of approximately $602 million) and a cost burden of approximately
$580 million in the first year. In each subsequent year the total
burden hours are estimated to be approximately 2.8 million hours (with
an associated equivalent cost of approximately $314 million) and the
cost burden is estimated at approximately $431 million.
These paperwork burden estimates are summarized as follows:
Type of Review: Revised Collection.
Agency: Employee Benefits Security Administration, Department of
Labor.
Titles: Final Statutory Exemption for the Provision of Investment
Advice to Participants and Beneficiaries of Participant-Directed
Individual Account Plans and IRAs.
OMB Control Number: 1210-0134.
Affected Public: Business or other for-profit.
Estimated Number of Respondents: 16,000.
Estimated Number of Annual Responses: 20,684,000.
Frequency of Response: Initially, Annually, Upon Request, when a
material change.
Estimated Total Annual Hour Burden: 5,179,000 hours in the first
year; 2,849,000 hours in each subsequent year (with associated three
year annualized hour burden of 3,626,000).
Estimated Total Annual Cost Burden: $580,272,000 in the first year;
$430,973,000 for each subsequent year (with associated three year
annualized cost burden of $480,739,000).
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Exemptions, Fiduciaries, Investments,
Pensions, Prohibited transactions, Reporting and recordkeeping
requirements, and Securities.
For the reasons set forth in the preamble, Chapter XXV, subchapter
F, part 2550 of Title 29 of the Code of Federal Regulations is amended
as follows:
PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY
0
1. The authority citation for part 2550 is revised to read as follows:
Authority: 29 U.S.C. 1135; and Secretary of Labor's Order No.
6-2009, 74 FR 21524 (May 7, 2009). Secs. 2550.401b-1, 2550.408b-1,
2550.408b-19, 2550.408g-1, and 2550.408g-2 also issued under sec.
102, Reorganization Plan No. 4 of 1978, 5 U.S.C. App. Sec.
2550.401c-1 also issued under 29 U.S.C. 1101. Sections 2550.404c-1
and 2550.404c-5 also issued under 29 U.S.C. 1104. Sec. 2550.407c-3
also issued under 29 U.S.C. 1107. Sec. 2550.404a-2 also issued under
26 U.S.C. 401 note (sec. 657(c)(2), Pub. L. 107-16, 115 Stat. 38,
136 (2001)). Sec. 2550.408b-1 also issued under 29 U.S.C.
1108(b)(1). Sec. 2550.408b-19 also issued under sec. 611(g)(3),
Public Law 109-280, 120 Stat. 780, 975 (2006).
0
2. Add Sec. 2550.408g-1 to read as follows:
Sec. 2550.408g-1 Investment advice--participants and beneficiaries.
(a) In general. (1) This section provides relief from the
prohibitions of section 406 of the Employee Retirement Income Security
Act of 1974, as amended (ERISA or the Act), and section 4975 of the
Internal Revenue Code of 1986, as amended (the Code), for certain
transactions in connection with the provision of investment advice to
participants and beneficiaries. This section, at paragraph (b),
implements the statutory exemption set forth at sections 408(b)(14) and
408(g)(1) of ERISA and sections 4975(d)(17) and 4975(f)(8) of the Code.
The requirements and conditions set forth in this section apply solely
for the relief described in paragraph (b) of this section and,
accordingly, no inferences should be drawn with respect to requirements
applicable to the provision of investment advice not addressed by this
section.
[[Page 66163]]
(2) Nothing contained in ERISA section 408(g)(1), Code section
4975(f)(8), or this regulation imposes an obligation on a plan
fiduciary or any other party to offer, provide or otherwise make
available any investment advice to a participant or beneficiary.
(3) Nothing contained in ERISA section 408(g)(1), Code section
4975(f)(8), or this regulation invalidates or otherwise affects prior
regulations, exemptions, interpretive or other guidance issued by the
Department of Labor pertaining to the provision of investment advice
and the circumstances under which such advice may or may not constitute
a prohibited transaction under section 406 of ERISA or section 4975 of
the Code.
(b) Statutory exemption. (1) General. Sections 408(b)(14) and
408(g)(1) of ERISA provide an exemption from the prohibitions of
section 406 of ERISA for transactions described in section 408(b)(14)
of ERISA in connection with the provision of investment advice to a
participant or a beneficiary if the investment advice is provided by a
fiduciary adviser under an ``eligible investment advice arrangement.''
Sections 4975(d)(17) and (f)(8) of the Code contain parallel provisions
to ERISA sections 408(b)(14) and (g)(1).
(2) Eligible investment advice. For purposes of section 408(g)(1)
of ERISA and section 4975(f)(8) of the Code, an ``eligible investment
advice arrangement'' means an arrangement that meets either the
requirements of paragraph (b)(3) of this section or paragraph (b)(4) of
this section, or both.
(3) Arrangements that use fee leveling. For purposes of this
section, an arrangement is an eligible investment advice arrangement
if--
(i)(A) Any investment advice is based on generally accepted
investment theories that take into account the historic risks and
returns of different asset classes over defined periods of time,
although nothing herein shall preclude any investment advice from being
based on generally accepted investment theories that take into account
additional considerations;
(B) Any investment advice takes into account investment management
and other fees and expenses attendant to the recommended investments;
(C) Any investment advice takes into account, to the extent
furnished by a plan, participant or beneficiary, information relating
to age, time horizons (e.g., life expectancy, retirement age), risk
tolerance, current investments in designated investment options, other
assets or sources of income, and investment preferences of the
participant or beneficiary. A fiduciary adviser shall request such
information, but nothing in this paragraph (b)(3)(i)(C) shall require
that any investment advice take into account information requested, but
not furnished by a participant or beneficiary, nor preclude requesting
and taking into account additional information that a plan or
participant or beneficiary may provide;
(D) No fiduciary adviser (including any employee, agent, or
registered representative) that provides investment advice receives
from any party (including an affiliate of the fiduciary adviser),
directly or indirectly, any fee or other compensation (including
commissions, salary, bonuses, awards, promotions, or other things of
value) that varies depending on the basis of a participant's or
beneficiary's selection of a particular investment option; and
(ii) The requirements of paragraphs (b)(5), (6), (7), (8) and (9)
and paragraph (d) of this section are met.
(4) Arrangements that use computer models. For purposes of this
section, an arrangement is an eligible investment advice arrangement if
the only investment advice provided under the arrangement is advice
that is generated by a computer model described in paragraphs (b)(4)(i)
and (ii) of this section under an investment advice program and with
respect to which the requirements of paragraphs (b)(5), (6), (7), (8)
and (9) and paragraph (d) are met.
(i) A computer model shall be designed and operated to--
(A) Apply generally accepted investment theories that take into
account the historic risks and returns of different asset classes over
defined periods of time, although nothing herein shall preclude a
computer model from applying generally accepted investment theories
that take into account additional considerations;
(B) Take into account investment management and other fees and
expenses attendant to the recommended investments;
(C) Appropriately weight the factors used in estimating future
returns of investment options;
(D) Request from a participant or beneficiary and, to the extent
furnished, utilize information relating to age, time horizons (e.g.,
life expectancy, retirement age), risk tolerance, current investments
in designated investment options, other assets or sources of income,
and investment preferences; provided, however, that nothing herein
shall preclude a computer model from requesting and taking into account
additional information that a plan or a participant or beneficiary may
provide;
(E) Utilize appropriate objective criteria to provide asset
allocation portfolios comprised of investment options available under
the plan;
(F) Avoid investment recommendations that:
(1) Inappropriately favor investment options offered by the
fiduciary adviser or a person with a material affiliation or material
contractual relationship with the fiduciary adviser over other
investment options, if any, available under the plan; or
(2) Inappropriately favor investment options that may generate
greater income for the fiduciary adviser or a person with a material
affiliation or material contractual relationship with the fiduciary
adviser; and
(G)(1) Except as provided in paragraph (b)(4)(i)(G)(2) of this
section, take into account all designated investment options, within
the meaning of paragraph (c)(1) of this section, available under the
plan without giving inappropriate weight to any investment option.
(2) A computer model shall not be treated as failing to meet the
requirements of this paragraph merely because it does not make
recommendations relating to the acquisition, holding or sale of an
investment option that:
(i) Constitutes an annuity option with respect to which a
participant or beneficiary may allocate assets toward the purchase of a
stream of retirement income payments guaranteed by an insurance
company, provided that, contemporaneous with the provision of
investment advice generated by the computer model, the participant or
beneficiary is also furnished a general description of such options and
how they operate; or
(ii) The participant or beneficiary requests to be excluded from
consideration in such recommendations.
(ii) Prior to utilization of the computer model, the fiduciary
adviser shall obtain a written certification, meeting the requirements
of paragraph (b)(4)(iv) of this section, from an eligible investment
expert, within the meaning of paragraph (b)(4)(iii) of this section,
that the computer model meets the requirements of paragraph (b)(4)(i)
of this section. If, following certification, a computer model is
modified in a manner that may affect its ability to meet the
requirements of paragraph (b)(4)(i), the fiduciary adviser shall, prior
to utilization of the modified model, obtain a new certification from
an eligible investment expert that the
[[Page 66164]]
computer model, as modified, meets the requirements of paragraph
(b)(4)(i).
(iii) The term ``eligible investment expert'' means a person that,
through employees or otherwise, has the appropriate technical training
or experience and proficiency to analyze, determine and certify, in a
manner consistent with paragraph (b)(4)(iv) of this section, whether a
computer model meets the requirements of paragraph (b)(4)(i) of this
section; except that the term ``eligible investment expert'' does not
include any person that: Has any material affiliation or material
contractual relationship with the fiduciary adviser, with a person with
a material affiliation or material contractual relationship with the
fiduciary adviser, or with any employee, agent, or registered
representative of the foregoing; or develops a computer model utilized
by the fiduciary adviser to satisfy this paragraph (b)(4).
(iv) A certification by an eligible investment expert shall--
(A) Be in writing;
(B) Contain--
(1) An identification of the methodology or methodologies applied
in determining whether the computer model meets the requirements of
paragraph (b)(4)(i) of this section;
(2) An explanation of how the applied methodology or methodologies
demonstrated that the computer model met the requirements of paragraph
(b)(4)(i) of this section;
(3) A description of any limitations that were imposed by any
person on the eligible investment expert's selection or application of
methodologies for determining whether the computer model meets the
requirements of paragraph (b)(4)(i) of this section;
(4) A representation that the methodology or methodologies were
applied by a person or persons with the educational background,
technical training or experience necessary to analyze and determine
whether the computer model meets the requirements of paragraph
(b)(4)(i); and
(5) A statement certifying that the eligible investment expert has
determined that the computer model meets the requirements of paragraph
(b)(4)(i) of this section; and
(C) Be signed by the eligible investment expert.
(v) The selection of an eligible investment expert as required by
this section is a fiduciary act governed by section 404(a)(1) of ERISA.
(5) Arrangement must be authorized by a plan fiduciary. (i) Except
as provided in paragraph (b)(5)(ii) of this section, the arrangement
pursuant to which investment advice is provided to participants and
beneficiaries pursuant to this section must be expressly authorized by
a plan fiduciary (or, in the case of an Individual Retirement Account
(IRA), the IRA beneficiary) other than: The person offering the
arrangement; any person providing designated investment options under
the plan; or any affiliate of either. Provided, however, that for
purposes of the preceding, in the case of an IRA, an IRA beneficiary
will not be treated as an affiliate of a person solely by reason of
being an employee of such person.
(ii) In the case of an arrangement pursuant to which investment
advice is provided to participants and beneficiaries of a plan
sponsored by the person offering the arrangement or a plan sponsored by
an affiliate of such person, the authorization described in paragraph
(b)(5)(i) of this section may be provided by the plan sponsor of such
plan, provided that the person or affiliate offers the same arrangement
to participants and beneficiaries of unaffiliated plans in the ordinary
course of its business.
(iii) For purposes of the authorization described in paragraph
(b)(5)(i) of this section, a plan sponsor shall not be treated as a
person providing a designated investment option under the plan merely
because one of the designated investment options of the plan is an
option that permits investment in securities of the plan sponsor or an
affiliate.
(6) Annual audit. (i) The fiduciary adviser shall, at least
annually, engage an independent auditor, who has appropriate technical
training or experience and proficiency, and so represents in writing to
the fiduciary adviser, to:
(A) Conduct an audit of the investment advice arrangements for
compliance with the requirements of this section; and
(B) Within 60 days following completion of the audit, issue a
written report to the fiduciary adviser and, except with respect to an
arrangement with an IRA, to each fiduciary who authorized the use of
the investment advice arrangement, in accordance with paragraph (b)(5)
of this section, that--
(1) Identifies the fiduciary adviser,
(2) Indicates the type of arrangement (i.e., fee leveling, computer
models, or both),
(3) If the arrangement uses computer models, or both computer
models and fee leveling, indicates the date of the most recent computer
model certification, and identifies the eligible investment expert that
provided the certification, and
(4) Sets forth the specific findings of the auditor regarding
compliance of the arrangement with the requirements of this section.
(ii) With respect to an arrangement with an IRA, the fiduciary
adviser:
(A) Within 30 days following receipt of the report from the
auditor, as described in paragraph (b)(6)(i)(B) of this section, shall
furnish a copy of the report to the IRA beneficiary or make such report
available on its Web site, provided that such beneficiaries are
provided information, with the information required to be disclosed
pursuant to paragraph (b)(7) of this section, concerning the purpose of
the report, and how and where to locate the report applicable to their
account; and
(B) In the event that the report of the auditor identifies
noncompliance with the requirements of this section, within 30 days
following receipt of the report from the auditor, shall send a copy of
the report to the Department of Labor at the following address:
Investment Advice Exemption Notification, U.S. Department of Labor,
Employee Benefits Security Administration, Room N-1513, 200
Constitution Ave., NW., Washington, DC 20210, or submit a copy
electronically to [email protected].
(iii) For purposes of this paragraph (b)(6), an auditor is
considered independent if it does not have a material affiliation or
material contractual relationship with the person offering the
investment advice arrangement to the plan or with any designated
investment options under the plan, and does not have any role in the
development of the investment advice arrangement, or certification of
the computer model utilized under the arrangement.
(iv) For purposes of this paragraph (b)(6), the auditor shall
review sufficient relevant information to formulate an opinion as to
whether the investment advice arrangements, and the advice provided
pursuant thereto, offered by the fiduciary adviser during the audit
period were in compliance with this section. Nothing in this paragraph
shall preclude an auditor from using information obtained by sampling,
as reasonably determined appropriate by the auditor, investment advice
arrangements, and the advice pursuant thereto, during the audit period.
(v) The selection of an auditor for purposes of this paragraph
(b)(6) is a fiduciary act governed by section 404(a)(1) of ERISA.
(7) Disclosure to participants. (i) The fiduciary adviser must
provide, without charge, to a participant or a beneficiary before the
initial provision of
[[Page 66165]]
investment advice with regard to any security or other property offered
as an investment option, a written notification of:
(A) The role of any party that has a material affiliation or
material contractual relationship with the fiduciary adviser in the
development of the investment advice program, and in the selection of
investment options available under the plan;
(B) The past performance and historical rates of return of the
designated investment options available under the plan, to the extent
that such information is not otherwise provided;
(C) All fees or other compensation that the fiduciary adviser or
any affiliate thereof is to receive (including compensation provided by
any third party) in connection with--
(1) The provision of the advice;
(2) The sale, acquisition, or holding of any security or other
property pursuant to such advice; or
(3) Any rollover or other distribution of plan assets or the
investment of distributed assets in any security or other property
pursuant to such advice;
(D) Any material affiliation or material contractual relationship
of the fiduciary adviser or affiliates thereof in the security or other
property;
(E) The manner, and under what circumstances, any participant or
beneficiary information provided under the arrangement will be used or
disclosed;
(F) The types of services provided by the fiduciary adviser in
connection with the provision of investment advice by the fiduciary
adviser;
(G) The adviser is acting as a fiduciary of the plan in connection
with the provision of the advice; and
(H) That a recipient of the advice may separately arrange for the
provision of advice by another adviser that could have no material
affiliation with and receive no fees or other compensation in
connection with the security or other property.
(ii)(A) The notification required under paragraph (b)(7)(i) of this
section must be written in a clear and conspicuous manner and in a
manner calculated to be understood by the average plan participant and
must be sufficiently accurate and comprehensive to reasonably apprise
such participants and beneficiaries of the information required to be
provided in the notification.
(B) The appendix to this section contains a model disclosure form
that may be used to provide notification of the information described
in paragraph (b)(7)(i)(C) of this section. Use of the model form is not
mandatory. However, use of an appropriately completed model disclosure
form will be deemed to satisfy the requirements of paragraphs (b)(7)(i)
and (ii) of this section with respect to such information.
(iii) The notification required under paragraph (b)(7)(i) of this
section may, in accordance with 29 CFR 2520.104b-1, be provided in
written or electronic form.
(iv) With respect to the information required to be disclosed
pursuant to paragraph (b)(7)(i) of this section, the fiduciary adviser
shall, at all times during the provision of advisory services to the
participant or beneficiary pursuant to the arrangement--
(A) Maintain accurate, up-to-date information in a form that is
consistent with paragraph (b)(7)(ii) of this section,
(B) Provide, without charge, accurate, up-to-date information to
the recipient of the advice no less frequently than annually,
(C) Provide, without charge, accurate information to the recipient
of the advice upon request of the recipient, and
(D) Provide, without charge, to the recipient of the advice any
material change to the information described in paragraph (b)(7)(i) at
a time reasonably contemporaneous to the change in information.
(8) Disclosure to authorizing fiduciary. The fiduciary adviser
shall, in connection with any authorization described in paragraph
(b)(5)(i) of this section, provide the authorizing fiduciary with a
written notice informing the fiduciary that:
(i) The fiduciary adviser intends to comply with the conditions of
the statutory exemption for investment advice under section 408(b)(14)
and (g) of the Employee Retirement Income Security Act and this
section;
(ii) The fiduciary adviser's arrangement will be audited annually
by an independent auditor for compliance with the requirements of the
statutory exemption and related regulations; and
(iii) The auditor will furnish the authorizing fiduciary a copy of
that auditor's findings within 60 days of its completion of the audit.
(9) Other conditions. The requirements of this paragraph are met
if--
(i) The fiduciary adviser provides appropriate disclosure, in
connection with the sale, acquisition, or holding of the security or
other property, in accordance with all applicable securities laws,
(ii) Any sale, acquisition, or holding of a security or other
property occurs solely at the direction of the recipient of the advice,
(iii) The compensation received by the fiduciary adviser and
affiliates thereof in connection with the sale, acquisition, or holding
of the security or other property is reasonable, and
(iv) The terms of the sale, acquisition, or holding of the security
or other property are at least as favorable to the plan as an arm's
length transaction would be.
(c) Definitions. For purposes of this section:
(1) The term ``designated investment option'' means any investment
option designated by the plan into which participants and beneficiaries
may direct the investment of assets held in, or contributed to, their
individual accounts. The term ``designated investment option'' shall
not include ``brokerage windows,'' ``self-directed brokerage
accounts,'' or similar plan arrangements that enable participants and
beneficiaries to select investments beyond those designated by the
plan. The term ``designated investment option'' has the same meaning as
the term ``designated investment alternative'' as defined in 29 CFR
2550.404a-5(h).
(2)(i) The term ``fiduciary adviser'' means, with respect to a
plan, a person who is a fiduciary of the plan by reason of the
provision of investment advice referred to in section 3(21)(A)(ii) of
ERISA by the person to the participant or beneficiary of the plan and
who is--
(A) Registered as an investment adviser under the Investment
Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) or under the laws of the
State in which the fiduciary maintains its principal office and place
of business,
(B) A bank or similar financial institution referred to in section
408(b)(4) of ERISA or a savings association (as defined in section
3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(b)(1)),
but only if the advice is provided through a trust department of the
bank or similar financial institution or savings association which is
subject to periodic examination and review by Federal or State banking
authorities,
(C) An insurance company qualified to do business under the laws of
a State,
(D) A person registered as a broker or dealer under the Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.),
(E) An affiliate of a person described in paragraphs (c)(2)(i)(A)
through (D), or
(F) An employee, agent, or registered representative of a person
described in paragraphs (c)(2)(i)(A) through (E) of this section who
satisfies the requirements of applicable insurance, banking, and
securities laws relating to the provision of advice.
[[Page 66166]]
(ii) Except as provided under 29 CFR 2550.408g-2, a fiduciary
adviser includes any person who develops the computer model, or markets
the computer model or investment advice program, utilized in
satisfaction of paragraph (b)(4) of this section.
(3) A ``registered representative'' of another entity means a
person described in section 3(a)(18) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a)(18)) (substituting the entity for the broker or
dealer referred to in such section) or a person described in section
202(a)(17) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-
2(a)(17)) (substituting the entity for the investment adviser referred
to in such section).
(4) ``Individual Retirement Account'' or ``IRA'' means--
(i) An individual retirement account described in section 408(a) of
the Code;
(ii) An individual retirement annuity described in section 408(b)
of the Code;
(iii) An Archer MSA described in section 220(d) of the Code;
(iv) A health savings account described in section 223(d) of the
Code;
(v) A Coverdell education savings account described in section 530
of the Code;
(vi) A trust, plan, account, or annuity which, at any time, has
been determined by the Secretary of the Treasury to be described in any
of paragraphs (c)(4)(i) through (v) of this section;
(vii) A ``simplified employee pension'' described in section 408(k)
of the Code; or
(viii) A ``simple retirement account'' described in section 408(p)
of the Code.
(5) An ``affiliate'' of another person means--
(i) Any person directly or indirectly owning, controlling, or
holding with power to vote, 5 percent or more of the outstanding voting
securities of such other person;
(ii) Any person 5 percent or more of whose outstanding voting
securities are directly or indirectly owned, controlled, or held with
power to vote, by such other person;
(iii) Any person directly or indirectly controlling, controlled by,
or under common control with, such other person; and
(iv) Any officer, director, partner, copartner, or employee of such
other person.
(6)(i) A person with a ``material affiliation'' with another person
means--
(A) Any affiliate of the other person;
(B) Any person directly or indirectly owning, controlling, or
holding, 5 percent or more of the interests of such other person; and
(C) Any person 5 percent or more of whose interests are directly or
indirectly owned, controlled, or held, by such other person.
(ii) For purposes of paragraph (c)(6)(i) of this section,
``interest'' means with respect to an entity--
(A) The combined voting power of all classes of stock entitled to
vote or the total value of the shares of all classes of stock of the
entity if the entity is a corporation;
(B) The capital interest or the profits interest of the entity if
the entity is a partnership; or
(C) The beneficial interest of the entity if the entity is a trust
or unincorporated enterprise.
(7) Persons have a ``material contractual relationship'' if
payments made by one person to the other person pursuant to contracts
or agreements between the persons exceed 10 percent of the gross
revenue, on an annual basis, of such other person.
(8) ``Control'' means the power to exercise a controlling influence
over the management or policies of a person other than an individual.
(d) Retention of records. The fiduciary adviser must maintain, for
a period of not less than 6 years after the provision of investment
advice under this section any records necessary for determining whether
the applicable requirements of this section have been met. A
transaction prohibited under section 406 of ERISA shall not be
considered to have occurred solely because the records are lost or
destroyed prior to the end of the 6-year period due to circumstances
beyond the control of the fiduciary adviser.
(e) Noncompliance. (1) The relief from the prohibited transaction
provisions of section 406 of ERISA and the sanctions resulting from the
application of section 4975 of the Code described in paragraph (b) of
this section shall not apply to any transaction described in such
paragraphs in connection with the provision of investment advice to an
individual participant or beneficiary with respect to which the
applicable conditions of this section have not been satisfied.
(2) In the case of a pattern or practice of noncompliance with any
of the applicable conditions of this section, the relief described in
paragraph (b) of this section shall not apply to any transaction in
connection with the provision of investment advice provided by the
fiduciary adviser during the period over which the pattern or practice
extended.
(f) Effective date and applicability date. This section shall be
effective December 27, 2011. This section shall apply to transactions
described in paragraph (b) of this section occurring on or after
December 27, 2011.
Appendix to Sec. 2550.408g-1
Fiduciary Adviser Disclosure
This document contains important information about [enter name
of Fiduciary Adviser] and how it is compensated for the investment
advice provided to you. You should carefully consider this
information in your evaluation of that advice.
[enter name of Fiduciary Adviser] has been selected to provide
investment advisory services for the [enter name of Plan]. [enter
name of Fiduciary Adviser] will be providing these services as a
fiduciary under the Employee Retirement Income Security Act (ERISA).
[enter name of Fiduciary Adviser], therefore, must act prudently and
with only your interest in mind when providing you recommendations
on how to invest your retirement assets.
Compensation of the Fiduciary Adviser and Related Parties
[enter name of Fiduciary Adviser] (is/is not) compensated by the
plan for the advice it provides. (if compensated by the plan,
explain what and how compensation is charged (e.g., asset-based fee,
flat fee, per advice)). (If applicable, [enter name of Fiduciary
Adviser] is not compensated on the basis of the investment(s)
selected by you.)
Affiliates of [enter name of Fiduciary Adviser] (if applicable
enter, and other parties with whom [enter name of Fiduciary Adviser]
is related or has a material financial relationship) also will be
providing services for which they will be compensated. These
services include: [enter description of services, e.g., investment
management, transfer agent, custodial, and shareholder services for
some/all the investment funds available under the plan.]
When [enter name of Fiduciary Adviser] recommends that you
invest your assets in an investment fund of its own or one of its
affiliates and you follow that advice, [enter name of Fiduciary
Adviser] or that affiliate will receive compensation from the
investment fund based on the amount you invest. The amounts that
will be paid by you will vary depending on the particular fund in
which you invest your assets and may range from --% to --%. Specific
information concerning the fees and other charges of each investment
fund is available from [enter source, such as: your plan
administrator, investment fund provider (possibly with Internet Web
site address)]. This information should be reviewed carefully before
you make an investment decision.
(if applicable enter, [enter name of Fiduciary Adviser] or
affiliates of [enter name of Fiduciary Adviser] also receive
compensation from non-affiliated investment funds as a result of
investments you make as a result of recommendations of [enter name
of Fiduciary Adviser]. The amount of this compensation also may vary
depending on the particular fund in which you invest. This
compensation may range from --% to --%. Specific information
concerning the fees and other charges of each investment fund is
[[Page 66167]]
available from [enter source, such as: your plan administrator,
investment fund provider (possibly with Internet Web site address)].
This information should be reviewed carefully before you make an
investment decision.
(if applicable enter, In addition to the above, [enter name of
Fiduciary Adviser] or affiliates of [enter name of Fiduciary
Adviser] also receive other fees or compensation, such as
commissions, in connection with the sale, acquisition or holding of
investments selected by you as a result of recommendations of [enter
name of Fiduciary Adviser]. These amounts are: [enter description of
all other fees or compensation to be received in connection with
sale, acquisition or holding of investments]. This information
should be reviewed carefully before you make an investment decision.
(if applicable enter, When [enter name of Fiduciary Adviser]
recommends that you take a rollover or other distribution of assets
from the plan, or recommends how those assets should subsequently be
invested, [enter name of Fiduciary Adviser] or affiliates of [enter
name of Fiduciary Adviser] will receive additional fees or
compensation. These amounts are: [enter description of all other
fees or compensation to be received in connection with any rollover
or other distribution of plan assets or the investment of
distributed assets]. This information should be reviewed carefully
before you make a decision to take a distribution.
Consider Impact of Compensation on Advice
The fees and other compensation that [enter name of Fiduciary
Adviser] and its affiliates receive on account of assets in [enter
name of Fiduciary Adviser] (enter if applicable, and non-[enter name
of Fiduciary Adviser]) investment funds are a significant source of
revenue for the [enter name of Fiduciary Adviser] and its
affiliates. You should carefully consider the impact of any such
fees and compensation in your evaluation of the investment advice
that [enter name of Fiduciary Adviser] provides to you. In this
regard, you may arrange for the provision of advice by another
adviser that may have no material affiliation with or receive no
compensation in connection with the investment funds or products
offered under the plan. This type of advice is/is not available
through your plan.
Investment Returns
While understanding investment-related fees and expenses is
important in making informed investment decisions, it is also
important to consider additional information about your investment
options, such as performance, investment strategies and risks.
Specific information related to the past performance and historical
rates of return of the investment options available under the plan
(has/has not) been provided to you by [enter source, such as: your
plan administrator, investment fund provider]. (if applicable enter,
If not provided to you, the information is attached to this
document.)
For options with returns that vary over time, past performance
does not guarantee how your investment in the option will perform in
the future; your investment in these options could lose money.
Parties Participating in Development of Advice Program or Selection of
Investment Options
Name, and describe role of, affiliates or other parties with
whom the fiduciary adviser has a material affiliation or contractual
relationship that participated in the development of the investment
advice program (if this is an arrangement that uses computer models)
or the selection of investment options available under the plan.
Use of Personal Information
Include a brief explanation of the following--What personal
information will be collected; How the information will be used;
Parties with whom information will be shared; How the information
will be protected; and When and how notice of the Fiduciary
Adviser's privacy statement will be available to participants and
beneficiaries.
Should you have any questions about [enter name of Fiduciary
Adviser] or the information contained in this document, you may
contact [enter name of contact person for fiduciary adviser,
telephone number, address].
0
3. Add Sec. 2550.408g-2 to read as follows:
Sec. 2550.408g-2 Investment advice--fiduciary election.
(a) General. Section 408(g)(11)(A) of the Employee Retirement
Income Security Act, as amended (ERISA), provides that a person who
develops a computer model or who markets a computer model or investment
advice program used in an ``eligible investment advice arrangement''
shall be treated as a fiduciary of a plan by reason of the provision of
investment advice referred to in ERISA section 3(21)(A)(ii) to the plan
participant or beneficiary, and shall be treated as a ``fiduciary
adviser'' for purposes of ERISA sections 408(b)(14) and 408(g), except
that the Secretary of Labor may prescribe rules under which only one
fiduciary adviser may elect to be treated as a fiduciary with respect
to the plan. Section 4975(f)(8)(J)(i) of the Internal Revenue Code, as
amended (the Code), contains a parallel provision to ERISA section
408(g)(11)(A) that applies for purposes of Code sections 4975(d)(17)
and 4975(f)(8). This section sets forth requirements that must be
satisfied in order for one such fiduciary adviser to elect to be
treated as a fiduciary with respect to a plan under an eligible
investment advice arrangement.
(b)(1) If an election meets the requirements in paragraph (b)(2) of
this section, then the person identified in the election shall be the
sole fiduciary adviser treated as a fiduciary by reason of developing
or marketing the computer model, or marketing the investment advice
program, used in an eligible investment advice arrangement.
(2) An election satisfies the requirements of this paragraph (b)
with respect to an eligible investment advice arrangement if the
election is in writing and such writing--
(i) Identifies the investment advice arrangement, and the person
offering the arrangement, with respect to which the election is to be
effective;
(ii) Identifies a person who--
(A) Is described in any of 29 CFR 2550.408g-1(c)(2)(i)(A) through
(E),
(B) Develops the computer model, or markets the computer model or
investment advice program, utilized in satisfaction of 29 CFR
2550.408g-1(b)(4) with respect to the arrangement, and
(C) Acknowledges that it elects to be treated as the only
fiduciary, and fiduciary adviser, by reason of developing such computer
model, or marketing such computer model or investment advice program;
(iii) Is signed by the person identified in paragraph (b)(2)(ii) of
this section;
(iv) Is furnished to the person who authorized the arrangement, in
accordance with 29 CFR 2550.408g-1(b)(5); and
(v) Is maintained in accordance with 29 CFR 2550.408g-1(d).
Signed at Washington, DC, this 5th day of October 2011.
Phyllis C. Borzi,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. 2011-26261 Filed 10-24-11; 8:45 am]
BILLING CODE 4510-29-P