[Federal Register Volume 74, Number 12 (Wednesday, January 21, 2009)]
[Rules and Regulations]
[Pages 3822-3853]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-710]
[[Page 3821]]
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Part III
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. 74, No. 12 / Wednesday, January 21, 2009 /
Rules and Regulations
[[Page 3822]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB13
Investment Advice--Participants and Beneficiaries
AGENCY: Employee Benefits Security Administration, Labor.
ACTION: Final rule.
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SUMMARY: This document contains final rules under the Employee
Retirement Income Security Act, and parallel provisions in the Internal
Revenue Code of 1986, relating to the provision of investment advice by
a fiduciary adviser to participants and beneficiaries in participant-
directed individual account plans, such as 401(k) plans, and
beneficiaries of individual retirement accounts (and certain similar
plans). These rules affect 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: These final rules are effective on March 23, 2009.
FOR FURTHER INFORMATION CONTACT: Fred Wong, Office of Regulations and
Interpretations, Employee Benefits Security Administration, (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 an investment
advice 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. 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 by a fiduciary 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).
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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 the provision of
investment advice might result in prohibited transactions.\2\ Most
recently, Congress and the Administration, responding to the need to
afford participants and beneficiaries greater access to professional
investment advice, amended the prohibited transaction provisions of
ERISA and the Code, as part of the Pension Protection Act of 2006
(PPA),\3\ 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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\2\ 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).
\3\ Public Law 109-280, 120 Stat. 780 (Aug. 17, 2006).
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Specifically, section 601 of the PPA added a statutory exemption
under sections 408(b)(14) and 408(g) of ERISA. Parallel provisions were
added to the Code at sections 4975(d)(17) and 4975(f)(8).\4\ Section
408(b)(14) sets forth the investment advice-related transactions that
will be exempt from the prohibitions of 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.
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\4\ 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 December 4, 2006, the Department published a Request for
Information (RFI) in the Federal Register soliciting information to
assist the Department in the development of regulations under sections
408(b)(14) and 408(g).\5\ Specifically, the Department invited
interested persons to address the qualifications for the ``eligible
investment expert'' that is required to certify that computer models
used in connection with the statutory exemption meet the requirements
of the statutory exemption. The Department also invited interested
persons to provide information to assist the Department in developing
procedures to be followed in certifying that a computer model meets the
requirements of the statutory exemption. The Department also invited
suggestions for a model disclosure form for purposes of the statutory
exemption. In response to the RFI, the Department received 24 letters
addressing a variety of issues presented by the statutory exemption.
These comments were taken into account in developing the proposed
regulations described below.
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\5\ 71 FR 70429. The Department, on the same date, also
published an RFI in the Federal Register soliciting information to
assist the Department in determining, as required by PPA section
601(b)(3), the feasibility of using computer models in connection
with individual retirement accounts. 72 FR 70427.
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On February 2, 2007, the Department issued Field Assistance
Bulletin 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.\6\
The Bulletin
[[Page 3823]]
also confirmed the applicability of the principles set forth in section
408(g)(10) [Exemption for plan sponsor and certain other fiduciaries]
to plan sponsors and fiduciaries who offered 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 for purposes of an eligible investment advice
arrangement described in section 408(g)(2)(A)(i).
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\6\ 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).
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On August 22, 2008, the Department published in the Federal
Register proposed regulations that would, upon adoption, implement the
provisions of the statutory exemption for the provision of investment
advice to participants and beneficiaries under sections 408(b)(14) and
408(g) of the Act and the parallel provisions in the Code (73 FR
49896). On the same date, the Department also published a proposed
class exemption that, upon adoption, would establish alternative
conditions for granting prohibited transaction relief in connection
with the provision of investment advice, and thereby promote the broad
availability of investment advice to both participants and
beneficiaries in individual account plans and beneficiaries with
individual retirement accounts (73 FR 49924). In response to these
proposals, the Department received forty-three comment letters.
On October 21, 2008, the Department held a public hearing at which
interested members of the public were afforded an additional
opportunity to present their views on the proposals. Eight
organizations testified at the hearing.
Set forth below is an overview of the final rules and an overview
of the major comments received on the proposed rules and class
exemption.
B. Overview of Final Sec. 2550.408g-1 and Public Comments
1. General
As noted above, the Department published both a proposed regulation
and a proposed class exemption pertaining to the furnishing of
investment advice to participants and beneficiaries. In an effort to
facilitate both use of and reference to the relief afforded by the
statutory exemption and the class exemption, the Department has
included both within a single final rule, discussed below. In this
regard, a number of paragraph, subparagraph and other reference changes
are reflected in the final rule to accommodate the merger of the two
proposals, as well as other changes. The provisions applicable to the
statutory exemption are set forth in paragraph (b) of the final rule
and the provisions applicable to the class exemption are set forth at
paragraph (d) of the final rule. In addition to the structural changes,
the final rule, while retaining the general requirements and substance
of the proposals, reflects a number of clarifying changes made in
response to suggestions and concerns from commenters on the proposals.
These suggestions and concerns are discussed below.
Paragraph (a)(1) of the final rule describes the general scope of
the final rule, referencing both the statutory exemption under sections
408(b)(14) and 408(g)(1) of ERISA and 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, and the class exemption, issued pursuant to the
Department's authority under section 408(a) of ERISA and section
4975(c)(2) of the Code, for certain transactions not otherwise covered
by the statutory exemption. In response to the concerns of some
commenters that the conditions of the final rule might be construed as
being applicable to all investment advice arrangements, without regard
to whether the provision of advice pursuant to such arrangements
involves prohibited transactions, paragraph (a)(1) makes clear that the
requirements and conditions of the final rule apply solely for the
relief described in the final rule and, accordingly, that no inferences
should be drawn with respect to the requirements applicable to the
provision of investment advice not addressed by the rule.
Commenters also requested that the final rule make clear that
nothing in the rule establishes an obligation on the part of plans or
plan sponsors to provide investment advice. Other commenters requested
that the Department reaffirm its view that neither the statutory
exemption under section 408(g)(1) nor the regulations issued thereunder
invalidate or otherwise affect prior guidance concerning the
circumstances under which the provision of investment advice would not
constitute a prohibited transaction. The Department addressed these
concerns in paragraphs (a)(2) and (a)(3), respectively. Paragraph
(a)(2) provides that nothing contained in ERISA section 408(g)(1), Code
section 4975(f)(8), the regulation or the class exemption 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, the regulation or the class
exemption 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.\7\
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\7\ See Field Assistance Bulletin 2007-1 (Feb. 2, 2007).
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One commenter requested confirmation that the provision of
investment advice pursuant to the final rule will not affect the relief
accorded plan fiduciaries under section 404(c) of the Act. It is the
view of the Department that there is nothing in the Act, Code, or this
final rule that, in connection with the offering or provision of
investment advice, would itself affect the availability of relief to
plan sponsors or other fiduciaries of the plan (with the exception of
the fiduciary advisers) otherwise available under section 404(c). The
Department notes that, as explained in Field Assistance Bulletin 2007-
1, 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).\8\ It is the view of the
Department that section 404(c) and the Department's regulations
thereunder do not limit the liability of fiduciary advisers that,
pursuant to the exemptions contained in the final rule, specifically
assume and acknowledge fiduciary responsibility for the provision of
investment advice, within the meaning of section 3(21)(A)(ii) and the
regulations issued thereunder, and related transactions; advice that
clearly is intended to serve as the primary basis for investment
decisions by plan participants and beneficiaries. Section 404(c)
provides relief for acts which are the direct and necessary result of a
participant's or beneficiary's exercise of control. The investment
advice (and related transactions) covered by the exemption and
furnished to participants and beneficiaries would not, in the
Department's view, be the direct and necessary result of a
participant's or
[[Page 3824]]
beneficiary's exercise of control and, accordingly, the fiduciary
adviser would not be relieved of liability for such advice. See
examples at paragraphs (f)(8) and (f)(9) of Sec. 2550.404c-1.
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\8\ See section 408(g)(10) and Field Assistance Bulletin 2007-1
for a discussion of a fiduciary's duty to prudently select and
monitor investment advisers.
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2. Statutory Exemption
a. General
Paragraph (b) of the final rule specifically addresses the
statutory exemption and applicable conditions set forth in section
408(g)(1) of the Act. Like the proposal, these provisions generally
track the requirements under section 408(g)(1) 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 (b)(1) provides that for purposes of the relief afforded
for transactions described in section 408(b)(14) (and section
4975(d)(17) of the Code) the investment advice must be 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.
With regard to the scope of relief, one commenter requested that
the Department clarify that transactions covered by the regulation and
the class exemption include extensions of credit and similar
transactions necessary to the execution and settlement of trades of
securities. 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
and class exemption, otherwise permissible transactions necessary for
the efficient execution and settlement of trades of securities, such as
extensions of credit in connection with settlements.
One commenter requested that the relief afforded by the regulation
and class exemption be extended to investment advice provided to plan
sponsors generally. The Department notes that the transactions
described in 408(b)(14), with respect to which relief is given if the
requirements of section 408(g)(1) are satisfied, are specifically
limited to certain transactions that involve the provision of
investment advice to a participant or beneficiary of a plan. The scope
of both the regulation and the related class exemption, therefore, were
limited to these transactions. While advice provided to plan
fiduciaries such as plan sponsors may well be similar in many respects
to advice provided to participants and beneficiaries, the Department
does not believe it would be appropriate, as part of this final rule,
without further notice and comment, to extend relief to transactions
involving investment advice provided to plan sponsors. Accordingly, the
Department has not adopted this suggestion.
One commenter requested that the Department confirm that 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
assets constitutes the provision of investment advice within the
meaning of section 3(21)(A)(ii) of ERISA for purposes of the statutory
exemption and the class exemption. It has long been the view of the
Department that the act of making individualized recommendations of
particular investment managers to plan fiduciaries may constitute the
provision of investment advice within the meaning of section 3(21)(A).
The fiduciary nature of that advice does not, in the Department's view,
change merely because the advice is being given to a plan participant
or beneficiary. Accordingly, it is the view of the Department that the
recommending of investment managers to participants and beneficiaries
may constitute the provision of investment advice for purposes of both
the statutory and class exemption contained in this final rule.
Paragraph (b)(2) provides that, for purposes of section 408(g)(1)
of the Act and 4975(f)(8) of the Code, an ``eligible investment advice
arrangement'' is an arrangement that meets the requirements of
paragraph (b)(3), applicable to arrangements that use fee-leveling, or
paragraph (b)(4), applicable to arrangements that use computer models,
or both.
b. Arrangements using fee-leveling
Paragraph (b)(3) sets forth the requirements applicable to
investment advice arrangements that use fee-leveling under the
statutory exemption. Paragraph (b)(3)(i) delineates the specific
requirements that must be met. In this regard, paragraph (b)(3)(i)(A)
of the final rule, like the proposal, 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, noting that additional considerations are not
precluded from being taking into account.
One commenter recommended that the investment advice also take into
account investment management and other fees attendant to the
recommended investment(s). The Department agrees that the fees and
expenses attendant to an investment are an important consideration and
should be factored into individualized recommendations. Given the
Department's various regulatory initiatives directed toward enhancing
the consideration of investment-related fees and expenses by plan
fiduciaries and plan participants and beneficiaries,\9\ the Department
believes that it is reasonable to expect fiduciary advisers, as well as
their computer models, to take such fees and expenses into account in
providing investment advice to the plan participants and beneficiaries.
The Department, therefore, has added a new provision, at paragraph
(b)(3)(i)(B), requiring arrangements that utilize fee-leveling to take
into account investment management and other fees and expenses
attendant to the recommended investments. Similar changes appear in
paragraph (b)(4)(i)(B) for arrangements that use computer models, and
paragraph (d)(6)(i)(B), applicable to arrangements for providing advice
under the class exemption.
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\9\ See ``Fiduciary Requirements for Disclosure in Participant-
Directed Individual Account Plans,'' 73 FR 43013 (July 23, 2008)
(proposed rule); ``Reasonable Contract or Arrangement under Section
408(b)(2)--Fee Disclosure; Proposed Rule,'' 73 FR 70987 (Dec. 13,
2007); and Notice of adoption of revisions to annual return/report
forms, 72 FR 64731, 64788-794, 64824-28 (Nov. 16, 2007) (form and
instructions for the Schedule C (From 5500), ``Service Provider
Information'').
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Paragraph (b)(3)(i)(C) of the final rule requires that arrangements
utilizing fee-leveling must take into account certain personal
information furnished by a participant or beneficiary. In the proposal,
this information related to age, life expectancy, retirement age, risk
tolerance, other assets or sources of income and investment
preferences. The Department received a number of comments on this
provision. Many of the commenters requested clarification that the
delineated factors were not mandatory, some of the commenters noting
that the fiduciary adviser may not have the information, participants
may not be willing to give the information or the information they
furnish may be incomplete. Other commenters recommended that the
[[Page 3825]]
information focus on ``time horizons'' rather than life expectancy or
retirement age, noting the use of ``time horizons'' by the Financial
Industry Regulatory Authority (FINRA) in its guidance on determining
the suitability of a recommendation.
For purposes of the final rule, the Department retained the factors
delineated in the statute, section 408(g)(3)(B)(ii) of ERISA, as
examples of the information investment advice should be capable of
taking into account. The Department also has included in the final
rule, as an additional factor, information pertaining to the
participant's or beneficiary's current investments in designated
investment options. The Department believes that these factors are so
fundamental to meaningful investment advice, the Department is applying
the personal information requirement to all advice provided under the
statutory exemption and class exemption. However, the Department notes
that the information is only required to be taken into account to the
extent that a participant or beneficiary actually provides such
information. There is no obligation, therefore, for a fiduciary adviser
to factor in personal information that it does not have or that the
participant or beneficiary fails or refuses to provide. Rather, the
fiduciary adviser is merely required to request the personal
information described in the final rule, and utilize such information
only to the extent furnished. The Department has modified the text of
the final rule to provide this clarification. The Department also has
modified the language of the final rule to reference ``time horizons,''
and by parenthetical citation to life expectancy and retirement age as
examples of such time horizons. Similar changes are reflected in
paragraph (b)(4)(i)(C), for arrangements utilizing computer models, and
paragraph (d)(6)(i)(C), applicable to arrangements for providing advice
under the class exemption.
Paragraphs (b)(3)(i)(D) and (E) of the final rule set forth the
limitations on fees and compensation at the employee, agent and
registered representative level and the fiduciary adviser level,
respectively, applicable to arrangements utilizing fee-leveling under
the statutory exemption. These limitations are unchanged from the
proposal. Paragraph (b)(3)(i)(D) provides that any fees or other
compensation (including salary, bonuses, awards, promotions,
commissions or other things of value) received, directly or indirectly,
by any employee, agent or registered representative that provides
investment advice on behalf of a fiduciary adviser cannot vary
depending on the basis of any investment option selected by a
participant or beneficiary. Paragraph (b)(3)(i)(E) provides that any
fees (including any commission or other compensation) received by the
fiduciary adviser for investment advice or with respect to the sale,
holding, or acquisition of any security or other property for purposes
of investment of plan assets may not vary depending on the basis of any
investment option selected by a participant or beneficiary.
While a number of commenters supported the Department's application
of the fee-leveling requirement, some commenters objected to the
Department's implementation of the statutory provision, arguing that
Congress, in an effort to eliminate the potential for conflicts of
interest, intended the fee-leveling requirement to encompass not only
the fiduciary adviser but also affiliates of the fiduciary adviser. The
Department disagrees with this interpretation of the section
408(g)(2)(A)(i). Shortly after enactment of the PPA, the Department
issued Field Assistance Bulletin 2007-1 (February 2, 2007) setting
forth its legal analysis of the fee-leveling requirements in section
408(g)(2)(A)(i) of the Act.
In that Bulletin, the Department noted that it is clear from
section 408(g)(2)(A)(i) that only the fees or other compensation of the
fiduciary adviser may not vary. The Department explained that, in
contrast to other provisions of section 408(b)(14) and section 408(g),
section 408(g)(2)(A)(i) references only the fiduciary adviser, not the
fiduciary adviser or an affiliate. Inasmuch as a person, pursuant to
section 408(g)(11)(A), can be a fiduciary adviser only if that person
is a fiduciary of the plan by virtue of providing investment advice, an
affiliate of a registered investment adviser, a bank or similar
financial institution, an insurance company, or a registered broker
dealer will be subject to the varying fee limitation only if that
affiliate is providing investment advice to plan participants and
beneficiaries. The Department further explained that, consistent with
earlier guidance in this area, 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 would result solely by
reason of providing investment advice and thus there would be no need
for a prohibited transaction exemption, such as provided under sections
408(b)(14) and 408(g).\10\ The Department concluded that, for purposes
of section 408(g)(2)(A)(i), Congress could not have intended for the
requirement that fees not vary depending on the basis of any investment
options selected to extend to affiliates of the fiduciary adviser,
unless, of course, the affiliate is also a provider of investment
advice to a plan. This position continues to reflect the Department's
legal analysis of section 408(g)(2)(A)(i) and, therefore, is reflected
in the fee-leveling provisions of the final regulation.
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\10\ See AO 97-15A and AO 2005-10A.
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With regard to those commenters concerned about potential conflicts
of interest influencing the investment advice recommendations, the
Department believes that, while there may always be a few individuals
who, without regard to limitations imposed by law, abuse their position
of trust as fiduciaries, the safeguards established by the regulation,
as well as the class exemption, will, in the Department's view, remove
many of the incentives and create strong deterrents for abusive
behavior. In this regard, we note that, in addition to the specific
fee-leveling limitations, fiduciary advisers utilizing investment
advice arrangements that employ fee-leveling must comply with the
requirements of paragraphs (b)(5) [authorization by plan fiduciary],
(b)(6) [annual audits], (b)(7) [advance and annual disclosure], (b)(8)
[other conditions], and (e) [maintenance of records] of the final rule,
each of which is discussed in more detail below.
A number of commenters had questions or requested clarification of
the fee-leveling requirements applicable to employees, agents, or
registered representatives that provide advice on behalf of a fiduciary
adviser, now set forth in paragraph (b)(3)(i)(D) of the final rule. One
commenter asked for examples of things of value that an employee, agent
or representative might receive, directly or indirectly, that would
violate the rule. Paragraph (b)(3)(i)(D), like the proposal, delineates
a number of types of compensation that, if varied based on investment
options selected by a participant or beneficiary, would violate the
rule, namely salary, bonuses, awards, commissions, or other things of
value. Things of value would include trips, gifts and other things that
while having a value, are not given in the form of cash.
A number of commenters requested confirmation that bonus programs
based on the overall profitability of the fiduciary adviser or its
affiliate, or a designated business unit within the adviser's business
would not violate the
[[Page 3826]]
fee-leveling requirement. The application of the fee-leveling is
intended to be very broad in order to ensure that 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. 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, it is conceivable that a compensation or
bonus arrangement that is based on the overall profitability of an
organization may be permissible to the extent that it can be
established that the individual account plan and IRA investment advice
and investment option components were 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 this fee-leveling requirement ultimately depends on the
details of the program. In this regard, the Department notes that 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 and class exemption.
c. Arrangements Using Computer Models
As with the general requirements for arrangements using fee-
leveling, and like the proposal in most respects, the final rule
requires that arrangements utilizing computer models satisfy certain
basic requirements.\11\ These requirements include the application of
generally accepted investment theories (paragraph (b)(4)(i)(A)), the
consideration of investment management and other fees and expenses
attendant to recommended investments (paragraph (b)(4)(i)(B)), and the
utilization of certain participant-provided information (paragraph
(b)(4)(i)(C)). The changes to these requirements were discussed in
connection with the fee-leveling provisions of the regulation.
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\11\ In general, these requirements track the requirements set
forth in section 408(g)(3)(B) of the Act.
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Other conditions imposed on computer models require that such
models utilize objective criteria to provide asset allocation
portfolios (paragraph (b)(4)(i)(D)) and avoid recommendations that
inappropriately favor investments options offered by the fiduciary
adviser or that may generate greater income for the fiduciary adviser
or those with a material affiliation or material contractual
relationship with the fiduciary adviser (paragraph (b)(4)(i)(E)).
As with the proposal, the language of the final rule makes clear
that a computer model would not fail to meet the requirements of
paragraph (b)(4)(i)(E) merely because the only investment options
offered under the plan are options offered by the fiduciary adviser or
a person with a material affiliation or material contractual
relationship with the fiduciary adviser. The language also makes clear
that a computer model cannot be designed and operated to
inappropriately favor those investment options that generate the most
income for the fiduciary adviser or a person with a material
affiliation or material contractual relationship with the fiduciary
adviser. The final rule defines a ``material affiliation'' and
``material contractual relationship'' at paragraphs (c)(6) and (c)(7),
respectively.
One commenter requested clarification that the provisions of
paragraph (b)(4)(i)(E) would not be violated where an IRA beneficiary
requests investment advice with the understanding that the computer
model will be providing only hold or sell recommendations with respect
to investment options not offered 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 plan or 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)(E)
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. This view would also extend to the requirements of
the class exemption at paragraph (d)(3).
Paragraph (b)(4)(i)(F)(1) of the final rule, like the proposal,
requires that a computer model take into account all ``designated
investment options'' available under the plan without giving
inappropriate weight to any investment option.\12\ 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.
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\12\ See section 408(g)(3)(B)(v) of the Act.
---------------------------------------------------------------------------
Paragraph (b)(4)(i)(F)(2)(i) also, like the proposal, provides that
a computer model shall not be treated as failing to take all designated
investment options into account merely because it does not take into
account an investment option that constitutes an investment primarily
in qualifying employer securities. While most of the commenters on the
proposal supported the exclusion of qualifying employer securities,
some commenters requested clarification as to whether the computer
model nonetheless had to factor in the holding of such investments by a
participant or beneficiary, without regard to buy, sell or hold
recommendations.
It is the view of the Department that, absent a specific request
from the participant or beneficiary to exclude such assets from the
modeled investment advice, a computer model must take into account the
fact that the participant or beneficiary has such an investment when
giving advice with respect to the participant's or beneficiaries
remaining assets or investments. If, on the other hand, a participant
or beneficiary elects not to have such investments factored into the
modeled advice or does not provide such information and the computer
model does not have such information, the model would not be required
to take such assets into account in providing a recommendation. This
approach, in the Department's view, is consistent with the requirement
set forth in paragraph (b)(4)(i)(C) of the final rule that computer
models take into account other assets and investment preferences of the
participant or beneficiary. One commenter requested that the exclusion
for qualifying employer securities be expanded to apply to other single
asset funds, such as funds invested in stock
[[Page 3827]]
of prior employers or a spin-off company. The commenter did not
indicate other types of single asset funds, or the extent to which they
are offered as designated investment options under plans. The
Department does not believe it has sufficient information at this time
to extend similar treatment to any such investments.
Other commenters requested that computer models not be required to
include, among other things, options from predecessor plans (referred
to as ``legacy options''), managed accounts, target date funds, and in-
plan annuity options, which they described as annuity purchase programs
that serve as both accumulation and distribution options. With respect
to legacy options, it is the view of the Department that to the extent
participants continue to have an ability to further invest in such
options, the options must be included within the computer model. If, on
the other hand, participants are merely permitted to hold and sell
investments in such options, it is the view of the Department that, as
discussed above with respect to qualifying employer securities, unless
a participant specifically elects to not have such investments taken
into account, the model should take into account that the participant
holds such assets. Similar to the above, a computer model would not, in
the view of the Department, fail to meet the requirements of paragraph
(b)(4)(i)(F)(1) merely because it limits buy recommendations only to
those investment options that can be bought through the plan, even
though the model is capable of modeling hold and sell recommendations
with respect to other investments.
A few commenters noted that certain types of investment options,
such as managed accounts, life cycle-type funds, and funds that are
designed to manage assets taking into account a particular risk level
for the participant, rely on an investment manager to maintain the
asset allocation appropriate to its particular fund, product or service
and, therefore, that it serves no purpose to have such investments
included in another unrelated overlaying asset allocation analysis. The
Department agrees that where an investment fund, product or service is
itself designed to maintain a particular asset allocation taking into
account the time horizons (retirement age, life expectancy) or risk
level of a participant, such fund should not be required to be included
in the computer modeled investment advice. Similarly, the Department
believes that where, in connection with an in-plan annuity option, with
respect to which a participant may allocate a portion of his or her
assets toward the purchase of an annuitized retirement benefit and
those allocated assets are no longer available for investment at the
time of the advice, the participant or beneficiary has, in effect,
decided to treat those assets as no longer available for investment
and, accordingly, such assets should not, in the view of the
Department, be required to be modeled for purposes of buy, hold or sell
recommendations. On the other hand, when such options are available to
participants and beneficiaries, the Department believes that
participants and beneficiaries receiving modeled recommendations should
at the same time be furnished a general description of these options
and how they operate. This disclosure will assure that participants and
beneficiaries have information concerning all of their investment
choices, not merely those that can be modeled by a computer. This
treatment is set forth in paragraphs (b)(4)(i)(F)(2)(ii) and (iii).
Thus, under paragraph (b)(4)(i)(F)(2)(ii) of the final rule, a
computer model will not fail to meet the requirements of the regulation
merely because it does not make recommendations relating to the
acquisition, holding or sale of an investment fund, product or service
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 (such as retirement age or life expectancy) or
level of risk of the participant or beneficiary (e.g., life cycle-type
funds).
Similarly, paragraph (b)(4)(i)(F)(2)(iii) provides that a computer
model will not fail merely because it does not make recommendations
with respect to 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.
As noted above, however, the foregoing exceptions from the modeling
requirement apply only if participants and beneficiaries are provided,
contemporaneous with the provision of investment advice generated by
the computer model, information explaining the funds, products or
services, or in the case of an annuity, the option.
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
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); 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.
One commenter requested that the Department provide examples of
adequate credentials for an ``eligible investment expert.'' The
Department continues to believe that it is very difficult to define a
specific set of academic or other credentials that would serve to
define the appropriate expertise and experience for an eligible
investment expert. Unfortunately, for the same reason it is difficult
to define specific credentials for an eligible investment expert, it is
difficult to provide examples of the one or a set of credentials that
in every case would qualify an individual to make the required
certifications. The Department also is concerned that, even if an
example were possible, such an example may encourage unnecessary and
inappropriate reliance on the example as a person considered by the
Department to possess the necessary qualifications. For this reason,
the Department has not provided any examples of credentials for
eligible investment experts.
One commenter inquired whether the eligible investment expert is
required to 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
[[Page 3828]]
bonding requirements would be applicable to the eligible investment
expert.
One commenter requested confirmation that a fiduciary adviser's
selection and payment of an eligible investment expert is not itself a
per se prohibited transaction. It is the view of the Department that,
given the structure of the statutory exemption under section 408(g)(1)
and the expectation that a fiduciary adviser will obtain a
certification from an eligible investment expert, the selection and
payment of the fiduciary adviser is not a per se conflict, provided
that the eligible investment expert has neither a material affiliation
or material contractual relationship with the fiduciary adviser.
Moreover, the Department has made clear that the selection of an
eligible investment expert is a fiduciary act governed by section
404(a)(1) of the Act. See paragraph (b)(4)(v). Similarly, the selection
and payment of an auditor to conduct the audit required under the
statutory exemption or class exemption would not constitute a per se
conflict of interest. As noted in the preamble to the proposal, while
the rule gives latitude to a fiduciary adviser in selecting an eligible
investment expert to certify a computer model, 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.
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.
d. Authorization by a Plan Fiduciary
Paragraph (b)(5) of the final rule, consistent with section
408(g)(4) of ERISA, the proposed rule and proposed class exemption,
provides that 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. The final rule, like the proposals, further provides that, for
purposes of such authorization, an IRA beneficiary will not be treated
as an affiliate of a person solely by reason of being an employee of
such person, thereby enabling employees of a fiduciary adviser to take
advantage of investment advice arrangements offered by their employer
under the exemption.
A number of commenters requested that the authorizing language of
both the statutory exemption and class exemption be modified to permit
a fiduciary adviser to provide investment advice for the adviser's own
plan. The Department does not believe it is necessary or appropriate to
limit a fiduciary adviser's employee's choice of investment advice
providers to only competitors of the fiduciary adviser. Accordingly,
the Department has modified the authorization provisions of the final
regulation and class exemption to permit a fiduciary adviser to provide
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. (See paragraphs (b)(5)(ii) and (d)(5)(ii) of the final rule).
The Department notes, however, that neither the statutory exemption nor
the class exemption provides relief for the selection of the fiduciary
adviser or the arrangement pursuant to which advice will be provided.
Accordingly, plan fiduciaries must nonetheless be prudent in their
selection and may not, in contravention of section 406(b), use their
position to benefit themselves. 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) of the
Act.\13\
---------------------------------------------------------------------------
\13\ See 29 CFR 2550.408b-2(e)(3).
---------------------------------------------------------------------------
One commenter requested a clarification that, for purposes of the
authorization provision, a plan sponsor-fiduciary would not be treated
as the person providing a designated investment option under the plan
with respect to an option that is designed to invest in qualifying
employer securities. The Department did not intend, nor does it believe
Congress intended, to exclude employer-plan fiduciaries from
authorizing investment advice arrangements solely because the plan for
which the arrangement is being authorized offers participants the
opportunity to invest in qualifying employer securities. The Department
has added a provision to both the regulation and class exemption for
purposes of such clarification (see paragraphs (b)(5)(iii) and
(d)(5)(iii), respectively, of the final rule).
One commenter asked for a clarification as to whether an
authorizing plan fiduciary can rely on the representations of a
fiduciary adviser with respect to whether a computer model meets the
requirements of the regulation. Plan fiduciaries have an obligation to
prudently select, and periodically review that selection, fiduciary
advisers.\14\ In connection with an otherwise prudent and reasonable
selection and review process, the Department believes that an
authorizing plan fiduciary, in the absence of any information to the
contrary, may rely on the representations of a fiduciary adviser
regarding the fiduciary adviser's compliance with the requirements of
this rule.
---------------------------------------------------------------------------
\14\ See discussion in Field Assistance Bulletin 2007-01.
---------------------------------------------------------------------------
e. Annual Audit
Paragraph (b)(6) of the final rule sets forth the annual audit
requirements for the statutory exemption.\15\ 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 investment advice
arrangements for compliance with the requirements of the regulation
and, within 60 days
[[Page 3829]]
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, setting forth the specific findings of the auditor
regarding compliance of the arrangement with the requirements of the
regulation.
---------------------------------------------------------------------------
\15\ 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 final rule. The final rule, like
the proposal, provides that, with respect to an arrangement with an
IRA, the fiduciary adviser shall, within 30 days following receipt of
the report from the auditor, 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 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. With respect to making the report
available on a Web site, the Department believes that this alternative
to furnishing reports to IRA beneficiaries satisfies the requirement of
section 104(d)(1) of the Electronic Signatures in Global and National
Commerce Act (E-SIGN) \16\ 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 the proposal, and received no comments in response.
---------------------------------------------------------------------------
\16\ 15 U.S.C. 7004(d)(1) (2000).
---------------------------------------------------------------------------
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.
Paragraph (b)(6)(ii) of the final rule also provides, like the
proposal, that, when the report of the auditor identifies noncompliance
with the requirements of the regulation, 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 or class exemption.
For purposes of 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 any designated investment options under the
plan. See paragraph (b)(6)(iii). The terms ``material affiliation'' and
``material contractual relationship'' are defined in paragraphs (c)(6)
and (7) of the final rule, respectively.
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 as to the appropriate scope of its review and
the extent to which it can rely on representative samples for
determining compliance with the exemption.
While the audit provisions contained in the final rule are, with
respect to both the statutory exemption and the class exemption,
identical to the proposed audit requirements, the final rule does
contain new provisions making clear that, like the selection of an
eligible investment expert to certify a computer model, the selection
of the required auditor, for purposes of both the statutory exemption
and the class exemption, is a fiduciary act governed by section
404(a)(1) of ERISA. See paragraphs (b)(6)(v) and (d)(9)(v) of the final
rule.
A number of commenters raised issues or requested clarifications
regarding various aspects of the audit requirements.
One commenter requested that the Department establish that the
first annual audit required by the statutory exemption would not be
required to be completed until the end of 2009. Inasmuch as the audit
and other provisions of the regulation relating to the statutory
exemption closely track the provisions of the statutory exemption, the
Department is not persuaded that there is a basis for deferring the
completion of any otherwise required annual audit until the end of
2009. However, for purposes of any audits required to be completed
prior to the effective date of the final rule, the auditor may take
into account good faith compliance with the statute in the absence of
regulatory guidance.
One commenter requested that the Department should lessen the
burden on small advisers by modifying the audit requirement by, for
example, requiring an audit only every three years, rather than
annually. It is the view of the Department that the audit requirements
of both the statutory and class exemption are critical protections for
participants and beneficiaries in investment advice arrangements with
respect to which there is a possibility that an adviser may act in its
own self-interest rather than the interest of the plan's participants
and beneficiaries. No information or data has been furnished to the
Department that would support a finding that this risk to participants
and beneficiaries is any less from small advisers than large adviser.
Thus, the Department has no basis on which to determine what, if any,
special relief should be afforded small advisers. The final rule,
therefore, contains no special provisions for small advisers.
Another commenter suggested that rather than furnishing copies of
the audit report to authorizing fiduciaries and IRA beneficiaries,
fiduciary advisers should be required to inform the parties of the
availability of the reports and furnish such reports only in response
to requests. The Department did not adopt this suggestion. The
Department believes that, as with the audit, the reports of the auditor
are important and should be furnished to each authorizing plan
fiduciary. On the other hand, the Department recognizes that, in the
case of IRAs, furnishing a report to every IRA beneficiary may be
unduly burdensome and expensive, and, accordingly, provided a special
rule that permits the making available of the report on the fiduciary
adviser's Web site.
One commenter requested that fiduciary advisers have an additional
30 days to furnish the audit report to the authorizing plan
fiduciaries. Another commenter requested that the final rule provide 60
days for the furnishing of IRA-related audit reports. The Department
did not adopt these
[[Page 3830]]
suggestions. The Department notes, however, that the 60-day period
referenced in paragraphs (b)(6)(i)(B) and (d)(9)(i)(B) of the final
rule is the period following completion of the audit during which the
auditor is required to furnish its report to the fiduciary adviser and,
with the exception of an arrangement with an IRA, to each authorizing
fiduciary. The exception for arrangements with IRAs serves to relieve
the auditor from furnishing reports to the authorizing IRA
beneficiaries. Paragraphs (b)(6)(ii)(A) and (d)(9)(ii)(A) of the final
rule, applicable to arrangements with IRAs, place the obligation to
furnish the auditor's report on the fiduciary adviser and, in that
regard, require that the fiduciary adviser furnish the report or make
it available on its Web site within 30 days following receipt of the
report from the auditor. The Department did not receive any information
or data that would indicate that the aforementioned time frames
afforded the auditor and the fiduciary adviser are inadequate.
With regard to the qualifications of an auditor, one commenter
recommended that the auditor should be treated as a fiduciary. Other
commenters requested clarification that the audit is not required to be
conducted by an accountant or a lawyer. Another commenter requested
clarification as to the credentials necessary to conduct an audit. As
with the requirements for an ``eligible investment expert,'' the
Department does not believe that there is necessarily one set of
credentials, such as certified public accountant, auditor, or lawyer,
that is required or, conversely, by themselves 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 or
organization's experience and proficiency in conducting similar types
of audits. In this regard, it is the view of the Department that the
selection of an auditor is a fiduciary act and, therefore, 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. The Department also 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.
A number of comments requested clarification of the scope of the
audit, as now set forth in paragraphs (b)(6)(iv) and (d)(9)(iv) of the
final rule. In this regard, commenters requested clarification that the
permissible sampling of audits would be conducted at the fiduciary
adviser level and not the plan level, such that a sampling of each
plan's or IRA's transactions would not have to be audited. One
commenter requested clarification as to whether the audit could be
performed by a review of the audits conducted by the fiduciary
adviser's own personnel. 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. In the case of the class exemption, the
auditor is further required to review compliance with the fiduciary
adviser's policies and procedures, adopted in accordance with paragraph
(d)(7), designed to assure compliance with the exemption's
requirements. Accordingly, the precise nature and scope of the audit,
as well as how it is conducted, is 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.
While the Department believes that internal audits conducted by the
personnel of a fiduciary adviser are important to reducing the risks of
noncompliance with the conditions of the final rule, the Department
does not believe that it would be appropriate for an auditor to limit,
in any way, the scope of its audit based on such audits. Moreover, in
the view of the Department, the fiduciary adviser has a fiduciary duty
in selecting and monitoring an auditor to ensure that the required
audits are complete and fully independent of any audits conducted
internally by personnel of the fiduciary adviser. The Department notes,
however, that there is nothing in the final rule that would preclude
the independent auditor from working with the fiduciary adviser to
establish policies and procedures designed to enhance or ensure
compliance with the requirements of the statutory or class exemption,
provided that determinations of compliance with the statutory and class
exemption can be made without regard to such services.
Some commenters asked for a clarification of the ``independence''
requirements applicable to the auditor. Paragraphs (b)(6)(iii) and
(d)(9)(iii) of the final rule provide that an auditor is considered
independent if it does not have a material affiliation or material
contractual relationship with the fiduciary adviser or any person
offering designated investment options.
One commenter requested clarification that independence would not
be lost merely because the auditor performs other services for the
fiduciary adviser or its affiliates, such as performing audits or
certifying computer models, as an eligible investment expert. In
defining the term ``material contractual relationship,'' the Department
contemplated that there may be instances in which an auditor might be
performing other services for a fiduciary adviser or affiliates. While
one commenter recommended that the definition of material contractual
relationship be revised to preclude receipt of any compensation, the
Department believes that the 10% test set forth in paragraph (c)(7) of
the final rule, defining ``material contractual relationship,'' is
sufficient to minimize any influence on the part of the fiduciary
adviser that would serve to compromise the independence of the auditor.
Accordingly, the Department has not changed the final rule in this
regard.
A number of commenters expressed concern about the requirement, now
at paragraphs (b)(6)(ii)(B) and (d)(9)(ii)(B) of the final rule, that,
in the case of arrangements involving IRAs, the fiduciary adviser must
send a copy of the auditor's report to the Department if that report
identifies instances of noncompliance. Some commenters 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. As explained in the preamble to the
proposal, this filing requirement will enable the Department to monitor
compliance with the exemptions in those instances where there is no
authorizing ERISA plan fiduciary to carry out that function. While the
Department recognizes that not every instance of noncompliance would,
itself, affect the quality of the advice provided, the Department also
believes that, given the overall significance of the audit as a
protection for participants and beneficiaries, all reports that
identify noncompliance in this area should be furnished to the
Department for review, thereby, leaving to the Department the
opportunity to evaluate the significance of the noncompliance, the
function that an authorizing plan fiduciary would carry out for its
plan. Accordingly, the
[[Page 3831]]
Department is adopting the filing requirement as proposed.
f. Disclosure
The disclosure provisions are set forth in paragraph (b)(7) of the
final rule as they relate to the statutory exemption and paragraph
(d)(8) as they relate to the class exemption. In general, the
disclosure requirements for both the statutory and class exemption are
identical,\17\ and the provisions of the final rule, like the proposal,
track the requirements set forth in section 408(g)(6) of ERISA.
---------------------------------------------------------------------------
\17\ See paragraph (d)(8)(i)(C) that incorporates in the class
exemption compliance with the disclosure requirements under the
statutory exemption provisions as set forth in paragraphs
(b)(7)(i)(A) through (E), (G) and (H).
---------------------------------------------------------------------------
The final rule, at paragraphs (b)(7)(i) and (d)(8)(i), generally
requires that the fiduciary adviser provide to participants and
beneficiaries, 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, in the case of the
statutory exemption, the investment advice program or, in the case of
the class exemption, if applicable, the computer model or materials
described in paragraph (d)(3)(i) or (ii) of the final rule, 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 or in connection with the
sale, acquisition, or holding of the 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, including, with respect to an arrangement utilizing a computer
model, any limitations on the ability of the model to take into account
an investment primarily in qualifying employer securities; 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.
Paragraphs (b)(7)(ii)(A) and (d)(8)(ii)(A) of the final rule
require 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.
Paragraphs (b)(7)(ii)(B) and (d)(8)(ii)(B) of the final rule
reference the availability of a model disclosure form in the appendix
to the final rule. As with the proposals, the model disclosure form may
be used for purposes of satisfying the requirements set forth in
paragraphs (b)(7)(i)(C) and (d)(8)(i), as well as the requirements of
paragraphs (b)(7)(ii)(A) and (d)(8)(ii)(A) of the final rule. The final
rule, like the proposals, makes clear, however, that the use of the
model disclosure form is not mandatory. In response to several comments
addressing the general readability of the model form, the Department
has made minor changes to the form's organization and language.
Other commenters also made specific suggestions regarding the
content of the model disclosure form. Four commenters made suggestions
relating to the disclosure of fiduciary adviser cross-selling
practices, such as fees received by an adviser in connection with
rollovers to IRAs. As discussed below, given the potential for abuse in
this area, the text of the final rule has been modified to require the
disclosure of all fees or other compensation that a fiduciary adviser
or any affiliate might receive in connection with any rollover or other
distribution of plan assets or the investment of distributed assets.
Language has been added to the model form to reflect this disclosure
requirement.
Commenters presented a number of issues concerning the timing and
content of the proposed disclosure requirements. With regard to the
timing of the required disclosures, some commenters suggested that the
notifications be provided whenever advice is rendered; other commenters
argued that the annual disclosures should be required only when there
are material changes to the information furnished in advance of the
advice. Other commenters recommended that required notifications be
furnished quarterly. The Department did not adopt these
recommendations. 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. In this regard, the final
rule, like the proposal, requires notifications to be furnished in
advance of the advice, and annually thereafter, except that material
changes to such information are required to be furnished at a time
reasonably contemporaneous with the change in the information.
Commenters also raised issues concerning the content of the
required notifications. One commenter recommended that the Department
clarify that the required disclosure of fees and compensation was not
limited to designated investment options, but included fees and
compensation received in connection with investments made through open
brokerage windows and directed brokerage accounts. The disclosure
obligation set forth in paragraph (b)(7)(i)(C)(2) of the final rule is
very broad and includes any fees and other compensation that the
fiduciary adviser or affiliate might receive in connection with the
sale, acquisition, or holding of any security or other property
pursuant to the investment advice. There is nothing in this provision
which limits or is intended to limit the required disclosures to
compensation and fees in connection with designated investment options.
It is clear, therefore, that any compensation and fees to be received
in connection with investments through an open brokerage window or
directed brokerage account must be included in the required
disclosures.
Some commenters suggested that the required disclosure be required
to contain information pertaining to compensation and fees in
connection with rollovers or other distributions or the investment of
assets in connection with a rollover or other distribution. Given the
potential for abuse in this area, the Department agrees that such
information should be furnished to participants and beneficiaries. In
this regard, the final rule contains a specific provision that serves
to require the disclosure of all fees or other compensation that a
fiduciary adviser or any affiliate might receive in connection
[[Page 3832]]
with any rollover or other distribution of plan assets or the
investment of distributed assets in any security or other property
pursuant to the investment advice. See paragraph (b)(7)(i)(C)(3) of the
final rule, and paragraph (d)(8)(i)(C) of the final rule, which applies
several disclosures required for the statutory exemption to the class
exemption.
With regard to the practice of ``cross-selling,'' i.e., using
existing clients, plan participants and beneficiaries in this case, to
market additional services or products, the Department notes that,
while advising a participant or beneficiary to take an otherwise
permissible plan distribution would not normally constitute
``investment advice'' within the meaning of 29 CFR 2510.3-21(c), the
Department has taken a different position with respect to such
activities when the person making such recommendations is already a
plan fiduciary, as would be the case with a fiduciary adviser.\18\ When
a person is already acting in a fiduciary capacity with respect to the
plan, the Department has indicated that recommendations relating to the
taking of a distribution or the investment of amounts withdrawn from
the plan would constitute the exercise of discretionary authority
respecting management of the plan and, therefore must be undertaken
prudently and solely in the interest of the participant or beneficiary,
consistent with section 404(a)(1). The Department further notes that
if, for example, a fiduciary exercises control over plan assets to
cause a participant or beneficiary to take a distribution and then to
invest the proceeds in an IRA account managed by the fiduciary, the
fiduciary may be using plan assets in his or her own interest, in
violation of ERISA section 406(b)(1). The prohibited transaction relief
offered by the statutory and class exemption, which apply to
transactions related to the provision of investment advice to plan
participants or beneficiaries, would not cover such a violation.
Moreover, the Department is unable to conclude that the mere disclosure
of fees or other compensation received in connection with such a
distribution and investment, by itself, would be sufficient to avoid a
violation of section 406(b)(1). Because a fiduciary adviser, in making
recommendations related to the taking of a distribution or the
investment of amounts so withdrawn from the plan, may violate ERISA
section 404(a)(1) and/or 406(b)(1), authorizing plan fiduciaries, in
carrying out their duties under section 404(a)(1) in selecting and
periodically reviewing the adviser, may need to understand the extent
to which such recommendations will be made.
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\18\ See AO 2005-23A (Dec. 7, 2005).
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A commenter also suggested that the Department require disclosure
of information about the profitability of various plan investment
options to the fiduciary adviser. In addressing the need for disclosure
regarding plan investments being recommended by a fiduciary adviser
under the statutory exemption, Congress appears to have concluded that
the interests of participants and beneficiaries would be adequately
protected, in the context of the exemption's other conditions, by
information on all fees or other compensation that the fiduciary
adviser or any affiliate is to receive. The conditions of the
exemption, in general, focus on fees and compensation received in
connection with investments recommended rather than profitability of
those investments. Disclosures with respect to profitability of
investments options may require significantly more information and
effort to prepare than disclosures of fees and compensation, without
adding significant benefits. The Department does not believe it would
be appropriate, as part of this final rule, without further notice and
comment, to include such a disclosure obligation. Accordingly, the
Department has not adopted this suggestion.
A number of commenters requested that the Department confirm that
to the extent that the required disclosures are contained in disclosure
materials required to be prepared under securities and other laws, such
materials may be used for purposes of the exemptions. 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 paragraphs (b)(7)(ii)(A) and (d)(8)(ii)(A) are
satisfied.
The proposed regulation and class exemption provided that the
required notifications may, in accordance with 29 CFR 2520.104b-1, be
furnished in either written or electronic form. Several commenters
requested that the Department provide greater flexibility for notices
by electronic means, noting that the safe harbor for electronic
distributions, at Sec. 2520.104b-1(c), is not workable. The Department
currently is reviewing its rules relating to the use of electronic
media for disclosures under title I of ERISA. The Department notes
that, pending the issuance of further guidance, its current rule, at 29
CFR 2520.104b-1(c), is a safe harbor and, accordingly, represents
merely one permissible means by which documents under title I of ERISA
may be furnished to participants and beneficiaries electronically.
Nothing in that rule, therefore, forecloses other means by which
documents may, consistent with ERISA and the E-SIGN Act, be furnished
to participants and beneficiaries electronically.
Paragraphs (b)(7)(iv) and (d)(8)(iv) of the final rule set forth
miscellaneous recordkeeping and furnishing responsibilities of the
fiduciary adviser under the statutory and class exemption.
Specifically, these paragraphs require 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. Other Conditions
Paragraphs (b)(8) and (d)(10) of the final rule, like the
proposals, incorporate a series of miscellaneous, although important,
conditions set forth in section 408(g)(7) of ERISA. 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; any sale, acquisition, or holding of a security or
other property occurs solely at the direction of the recipient of the
advice; 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 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.
The Department received a number of comments requesting
clarification of the requirement that sales, acquisitions, or the
holding of securities or other
[[Page 3833]]
property occurs solely at the direction of the recipient of the advice.
In particular, commenters requested that the Department confirm that
the ``solely at the direction'' requirement is not violated solely by
virtue of a participant or beneficiary providing advance authorization
for a fiduciary adviser to periodically take steps to rebalance the
portfolio of the participant or beneficiary. One commenter requested
clarification that the ``solely at the direction'' requirement would
not be violated where, pursuant to an agreement with the participant or
beneficiary, investment advice recommendations will be acted upon by
the fiduciary adviser unless the participant or beneficiary objects
with the allotted period of time, typically 30 days.
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'' requirements of the final rule, 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 the
participant must be afforded advance notice of the fiduciary adviser's
intended investments and a reasonable opportunity, at least 30 days, to
object to the investments in order to comply with the ``solely at the
direction'' requirements of the final rule. With respect to a
recommendation involving a different asset allocation structure, the
Department believes that the participant or beneficiary must make an
affirmative direction for its implementation.
3. Definitions
Paragraph (c) sets forth definitions applicable to both the
statutory exemption and class exemption contained in the final rule.
Paragraph (c)(1) defines the term ``designated investment option.''
Paragraph (c)(2) defines the term ``fiduciary adviser.'' Paragraph
(c)(3) defines the term ``registered representative.'' Paragraph (c)(4)
defines the terms ``individual retirement account'' or ``IRA'' for
purposes of the final rule. Paragraph (c)(5) defines the term
``affiliate.'' And, paragraphs (c)(6) and (c)(7) define the terms
``material affiliation'' and ``material contractual relationship,''
respectively. Lastly, paragraph (c)(8) defines the term ``control.''
With the exception of a clarification in the definition of ``material
contractual relationship'' in paragraph (c)(7), the definitions were
adopted without change from the proposals.
One commenter requested that the Department clarify that the term
``agent'', as that term is used in the definition of ``fiduciary
adviser'' (see paragraph (c)(2)(i)(F) of the final rule), is not
limited to insurance agents. Another commenter requested that the
Department clarify that ``agents'' must be registered under the
Investment Advisers Act of 1940, unless otherwise exempt from
registration. It is the view of the Department that the term ``agent''
as used in the fiduciary adviser definition is not limited to insurance
agents or necessarily those registered under the Investment Advisers
Act, but rather encompasses persons acting on behalf of a fiduciary
adviser, applying agency law principles. The Department notes that the
definition, consistent with the statutory definition, requires that any
such agent satisfy the requirements of applicable insurance, banking
and securities laws relating to the provision of advice.
One commenter recommended a separate provision for investment
adviser representatives. It was not clear how such a separate
definition would substantively change the application of the fiduciary
adviser definition, at paragraph (c)(2); accordingly, the Department
did not adopt this suggestion.
One comment recommended that the Department adopt the definition of
``affiliate'' as set forth in 29 CFR 2510.3-21, rather than the
definition contained in the proposed rule. Section 408(g)(11)(C) of
ERISA provides that an ``affiliate'' of another entity means an
affiliated person of the entity as defined in section 2(a)(3) of the
Investment Company Act of 1940. The Department, therefore, adopted, as
discussed in the preamble to the proposal, the Investment Company Act
definition for purposes of both the proposal and this final rule, not
the definition set forth in Sec. 2510.3-21.
Finally, in order to clarify that the 10% gross revenue test,
applied for purposes of determining whether persons have a ``material
contractual relationship'' under the final rule, is not limited to
amounts paid pursuant to contracts or arrangements that have been
reduced to writing, the Department has deleted the word ``written''
from the definition contained in paragraph (c)(7).
4. Class exemption
A number of the issues pertaining to the conditions applicable to
the class exemption were raised and addressed in the above discussion
of the rules implementing the statutory exemption. The following
overview, therefore, will focus on those provisions and comments unique
to the class exemption and not previously addressed.
a. Authority and Findings
A number of commenters questioned the Department's authority to
grant the proposed class exemption arguing, in effect, that the
proposed class exemption is inconsistent with Congressional intent,
suggesting that enactment of the statutory exemption for investment
advice precluded or otherwise limited the Department's authority to
grant an administrative exemption under section 408(a). The Department
has carefully considered this issue and in so considering has been
unable to find anything in ERISA, the PPA, the Technical Explanation of
the PPA prepared by the staff of the Joint Committee on Taxation,\19\
or the case law that would serve to limit or otherwise restrict the
Department's ability to grant, in accordance with its authority in
section 408(a), an administrative exemption relating to the provision
of investment advice.
---------------------------------------------------------------------------
\19\ Technical Explanation of H.R. 5, The ``Pension Protection
Act of 2006'', as passed by the House on July 28, 2006, and as
considered by the Senate on August 3, 2006, prepared by the Staff of
the Joint Committee on Taxation, August 3, 2006, JCX 38-06.
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In fact, the Department has very broad authority under section
408(a) to grant conditional or unconditional exemptions for any
fiduciary or transaction or class of fiduciaries or transactions, from
all or part of the restrictions imposed by sections 406 and 407(a),
provided that the Secretary finds that such exemption is
administratively feasible, in the interests of the plan and its
participants and beneficiaries, and protective of the rights of
participants and beneficiaries.
The Department views the class exemption as necessary to provide
more comprehensive relief for fiduciary investment advice and to
address certain aspects of the statutory exemption that were unclear or
that did not extend relief to certain arrangements. For example, the
flush language in section 408(g)(3)(D) of
[[Page 3834]]
ERISA specifically permits participants to request individualized
advice after receipt of computer model-based advice, but does not
indicate whether any prohibited transaction relief would apply. In
addition, although the Department concluded that computer model-based
advice was feasible for IRAs to the extent that the advice takes into
account generally recognized asset classes, some IRAs do not limit
investment choices in this fashion. The class exemption therefore
provides substitute relief for advisers that may not be able to take
full advantage of computer model-based advice as to some IRAs.
Taking into account the intent of the Congress and the
administration to dramatically expand the availability of affordable,
quality investment advice for millions of America's workers
participating in participant-directed individual account plans and
IRAs, the Department concluded that the best approach to addressing the
ambiguities and issues presented by the PPA and statutory exemption was
to exercise its authority under section 408(a) of ERISA, building on
the carefully crafted safeguards of the statutory exemption established
by the Congress, safeguards that the Congress itself determined to be
administratively feasible, in the interests of the plan and its
participants and beneficiaries, and protective of the rights of
participants and beneficiaries.
A few commenters questioned whether the Department could make the
findings required by section 408(a) with respect to the class
exemption. As noted above, section 408(a) conditions exemptive relief
on a finding by the Department that the exemption is administratively
feasible, in the interests of the plan and its participants and
beneficiaries, and protective of the rights of participants and
beneficiaries. With regard to the class exemption contained in this
document, the Department finds that the exemption is administratively
feasible with respect to both compliance by fiduciary advisers electing
to provide investment advice to participants and beneficiaries and
enforcement by the Department. The Department finds that the exemption
is in the interest of plans and their participants and beneficiaries
because the availability of the exemption will significantly expand the
opportunities for millions of participants and beneficiaries in
participant-directed individual account plans and IRAs to obtain
affordable, quality investment advice that might otherwise not be
available to them. The Department further finds that the exemption is
protective of the rights of participants and beneficiaries because of
the conditions contained in the exemption intended to mitigate
conflicts of interest that might otherwise affect the quality of
investment advice. As noted above, the conditions of the class
exemption build on the protections Congress determined to be
administratively feasible, in the interest of plans and their
participants and beneficiaries, and protective of the rights of those
participants and beneficiaries for purposes of the statutory exemption
set forth in section 408(g). The specifics of these conditions are
discussed below, if not previously addressed in connection with the
statutory exemption provisions.
b. General
The final class exemption, like the statutory exemption described
in paragraph (b) of the final rule, provides relief from otherwise
prohibited transactions relating to the provision of investment advice
to a plan participant or beneficiary or IRA beneficiary; the
acquisition, holding or sale of a security or other property 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 pursuant to the investment advice.
Unlike the statutory exemption, however, the final class exemption,
like the proposed class exemption, provides relief for investment
advice provided to individuals following the furnishing of
recommendations generated by a computer model or, in instances where
computer modeling under the statutory exemption is not feasible, the
furnishing of investment education material. As explained in the
preamble to the proposal, the computer generated advice recommendations
and investment education materials are intended to provide individual
account plan participants and beneficiaries and IRA beneficiaries with
a context for assessing and evaluating the individualized investment
advice contemplated by the class exemption. Also, unlike the statutory
exemption, the final class exemption, like the proposal, applies the
fee-leveling limits solely to the compensation received by the
employee, agent or registered representative providing the advice on
behalf of the fiduciary adviser, as distinguished from compensation
received by the fiduciary adviser on whose behalf the employee, agent
or registered representative is providing such advice.
In general, the class exemption is intended to complement the
adoption of regulations implementing the statutory exemption by
furthering the availability of individualized investment advice to both
participants and beneficiaries in participant-directed individual
account plans and IRA beneficiaries under circumstances not clearly
encompassed by the statutory exemption or implementing regulations, as
described below.
c. Scope of Exemption
Paragraph (d)(1) of the final rule sets forth the scope of the
class exemption. Specifically paragraph (d)(1)(i) provides that, with
respect to the provision of advice to participants and beneficiaries of
individual account plans, the restrictions of sections 406(a) and
406(b) of ERISA and the sanctions resulting from the application of
section 4975 of the Code, by reason of section 4975(c)(1)(A) through
(F) of the Code, shall not apply to the provision of investment advice
described in section 3(21)(A)(ii) of the Act by a fiduciary adviser to
a participant or beneficiary of an individual account plan that permits
such participant or beneficiary to direct the investment of their
individual accounts; the acquisition, holding, or sale of a security or
other property pursuant to the investment advice; and, except as
otherwise provided in the exemption, the direct or indirect receipt of
fees or other compensation by the fiduciary adviser (or any employee,
agent, registered representative or affiliate thereof) in connection
with the provision of the advice or in connection with an acquisition,
holding, or sale of a security or other property pursuant to the
investment advice. Paragraph (d)(1)(ii) of the final rule provides the
same relief with respect to the sanctions resulting from the
application of section 4975 of the Code, by reason of section
4975(c)(1)(A) through (F) of the Code, for investment advice to
beneficiaries of IRAs.
d. Conditions for Relief
Paragraph (d)(2) of the final rule provides that the relief
described in paragraph (d)(1) is available if a fiduciary adviser
provides advice in accordance with paragraph (d)(3), relating to the
use of computer models and investment education materials, or paragraph
(d)(4), relating to the use of fee-level arrangements, or both. In
addition the fiduciary adviser must satisfy the conditions described in
paragraphs: (d)(5), requiring authorization by a plan fiduciary or IRA
beneficiary; (d)(6), relating to the basis for advice; (d)(7),
requiring policies and
[[Page 3835]]
procedures; (d)(8), requiring disclosure of specified information;
(d)(9), requiring an annual audit; and (d)(10), specifying other
miscellaneous conditions. With the exception of paragraph (d)(7),
relating to the adoption of policies and procedures, the aforementioned
requirements are modeled after, and were discussed in conjunction with,
the conditions of the statutory exemption and, accordingly, will not
again be described or reviewed in this section.
e. Post-computer Model--Investment Education Advice
Paragraph (d)(3) of the final rule, like the provision of the
proposed class exemption, requires that, in advance of a participant or
beneficiary being provided individualized investment advice, the
participant or beneficiary must be furnished investment recommendations
generated by either a computer model that meets the requirements of the
statutory exemption or a computer model developed by a person
independent of the fiduciary adviser. The proposal contained an
exception to the general computer modeling requirement for IRAs with
respect to which types or number of investment choices reasonably
precludes the use of a computer model that meets certain requirements
of the regulations under the statutory exemption.
The Department received a number of comments on this condition of
the proposal. One commenter requested that the Department clarify
whether a fiduciary adviser providing individualized advice to a
participant can utilize the recommendations generated by the computer
model of another fiduciary adviser. For example, according to this
commenter, a plan recordkeeper might offer participants access to a
proprietary computer model that complies with the statutory exemption,
and the plan sponsor might also provide access through a second advice
provider. The commenter asked whether the second advice provider could,
for purposes of the class exemption, rely on the computer model advice
furnished to a participant by the plan recordkeeper. The Department
does not believe one fiduciary adviser would necessarily be precluded
from using another fiduciary adviser's computer modeled recommendations
for a particular participant, provided that the requirements of
exemption for both the computer model and individualized advice are
otherwise satisfied and the individualized advice is reasonably
contemporaneous with the computer modeled advice.
One commenter suggested that, given the other safeguards contained
in the exemption, the requirement for computer modeled advice in
advance of individualized advice should be eliminated, noting that the
computer modeled advice will only confuse participants and limit the
advisers. The Department disagrees. The Department continues to believe
that the furnishing of computer modeled investment recommendations is
an important protection and tool for participants in assessing and
evaluating the individualized recommendations of the fiduciary adviser.
The computer modeled advice provides participants and beneficiaries a
means by which they can assess and question, in advance of an
investment decision, the extent to which the recommendations of the
fiduciary adviser deviate from modeled advice. For this reason, the
Department did not adopt the commenter's suggestion.
One commenter recommended that post-model/education advice be
subject to a fee-leveling requirement. The Department did not adopt
this suggestion. First, the Department believes that the class
exemption contains sufficient safeguards without a fee-leveling
requirement to protect participants and beneficiaries against biased,
inappropriate investment advice. Second, given such safeguards, the
Department does not believe it is appropriate to favor one business
model for providing investment advice over another business model,
i.e., those fiduciary advisers that use fee-leveling over those that do
not, particularly when doing so may only serve to limit the
availability of investment advice to participants and beneficiaries.
Several commenters argued that the exception from the class
exemption's computer modeling requirement that was provided to certain
IRAs (i.e., where the types or number of investment choices reasonably
precludes use of computer model meeting the requirements of the
statutory exemption) be extended to brokerage windows and similar
arrangements with respect to which the computer modeling of investment
recommendations is not feasible and that, without such an exception,
plan participants and beneficiaries utilizing such windows or accounts
may not have access to the investment advice they need. The Department
is persuaded that brokerage windows and similar arrangements that
permit participants to invest beyond a plan's designated investment
options present the same computer modeling difficulties that are
encountered by IRAs that impose few restrictions on a beneficiary's
investment choices. However, with regard to plans that offer
participants and beneficiaries both designated investment options and a
brokerage window or similar arrangement, the Department believes
participants and beneficiaries electing to utilize such arrangements
would, in addition to investment education materials, also benefit from
receiving computer modeled investment recommendations with respect to
the plan's designated investment options in advance of being provided
individualized investment advice. As with those participants and
beneficiaries whose investment options, either by plan design or
choice, are limited to designated investment options, the Department
believes that computer modeled investment recommendations will help
participants and beneficiaries considering the use of a brokerage
window or similar arrangement assess the investment choices available
through both the brokerage window and the plan, as well as the
individualized investment recommendations and strategies of the
fiduciary adviser. The exception contained in the final class
exemption, at paragraph (d)(3)(ii)(A) of the final rule, reflects this
position.
Specifically, paragraph (d)(3)(ii)(A) provides that, in the case of
a plan that offers a ``brokerage window'', ``self-directed brokerage
account'' or similar arrangement that enables participants and
beneficiaries to select investments beyond those designated by the
plan, if any, before providing investment advice with respect to any
investment utilizing such arrangement, the participant or beneficiary
shall be furnished the investment education material described in
paragraph (d)(3)(ii)(B) and, if the plan offers designated investment
options, the participant or beneficiary also shall be furnished the
recommendations generated by a computer model, as required by paragraph
(d)(3)(i), with regard to such options.
Some commenters, while supporting the exception from computer
modeling for IRAs, requested that the Department provide further
guidance concerning when the types or number of investment choices
would reasonably preclude the use of a computer model to generate
investment recommendations. The Department believes that there are a
variety of factors that may serve to reasonably preclude use of a
computer model for generating recommendations with respect to the
investments available under an IRA, including the number of investment
options offered, the type of investment options (such as
[[Page 3836]]
investments in individual securities), and the relative costs of
developing and maintaining such computer models and benefits of
offering such model-generated advice services to IRA beneficiaries. The
Department believes this will be an evolving, rather than static,
standard. As computer modeling of investment advice develops, the
Department anticipates that the feasibility of developing models to
take into account a wider variety of investment choices also will
change. The Department has retained the IRA exception without change
from the proposal. See paragraph (d)(3)(ii)(B) of the final rule.
The investment education material required to be furnished under
the final rule is identical to that described in the proposal.
Specifically, paragraph (d)(3)(ii)(B) of the final rule requires that
participants and beneficiaries be furnished with material, such as
graphs, pie charts, case studies, worksheets, or interactive software
or similar programs, that reflect or produce asset allocation models
taking into account the age (or time horizon) and risk profile of the
beneficiary, to the extent known. As with the proposal, the final rule
makes clear that nothing precludes the furnishing of material, in
addition to the foregoing, reflecting asset allocation portfolios of
hypothetical individuals with different time horizons and risk
profiles.
Also like the proposal, the final rule also requires that: (A)
Models must be based on generally accepted investment theories that
take into account the historic returns of different asset classes
(e.g., equities, bonds, or cash) over defined periods of time; (B) such
models must operate in a manner that is not biased in favor of
investments offered by the fiduciary adviser or a person with a
material affiliation or material contractual relationship with the
fiduciary adviser; and (C) all material facts and assumptions on which
such models are based (e.g., retirement ages, life expectancies, income
levels, financial resources, replacement income ratios, inflation
rates, and rates of return) accompany the models.
The proposal further required that the provided individualized,
rather than computer modeled, investment advice (post-model/investment
education advice) not recommend investment options that may generate
for the fiduciary adviser, or certain other persons, greater income
than other options of the same asset class, unless the fiduciary
adviser prudently concludes that the recommendation is in the best
interest of the participant or beneficiary and explains the basis for
that conclusion to the participant or beneficiary. The proposal further
required that the advice provider document the basis of any advice
given to the participant or beneficiary within 30 days following the
provision of the advice.
One commenter objected to the requirement that the furnished advice
be documented, arguing that the advisers are required to comply with
both ERISA prudence standards and FINRA suitability standards and that
the documentation requirement does not add any additional protection.
Another commenter argued that such explanations were not sufficiently
protective of participants and beneficiaries. The Department disagrees
with these comments. One of the many protections encompassed in the
class exemption is the audit requirement. The Department expects that a
critical part of the audit will involve a review of the explanations
required to be documented by the fiduciary adviser. Without such
documentation, auditors would have no basis for assessing compliance
with a number of the conditions of the class exemption, including those
set forth in paragraphs (d)(3)(ii)(A) and (B) and (d)(6) of the final
rule.
One comment misconstrued the requirement, reading the proposal as
not requiring the fiduciary adviser to provide an explanation regarding
investments that might generate higher fees until 30 days after the
provision of the advice. Under the proposal, the explanation was
required to be provided in advance of the advice, but that explanation
was not required to be documented for the fiduciary adviser's records,
as well as for the required audit, until 30 days after the provision of
the advice. The Department believes that it may not always be practical
for a fiduciary adviser to document the advice they provide
contemporaneously with the provision of that advice and, therefore,
provided a limited period within which such advice must be documented.
In an effort to address both ambiguity and confusion with respect
to the aforementioned requirement, the Department has combined and
simplified the requirement for purposes of the final class exemption.
Further, because the Department believes that this requirement, in its
revised form, would offer additional protections to participants and
beneficiaries without being unnecessarily burdensome on fiduciary
advisers, the Department is making it a general requirement of the
final class exemption. In this regard, paragraph (d)(6)(ii) of the
final rule provides that, in connection with the provision of any
investment advice covered by the class exemption, the fiduciary adviser
must conclude that the advice to be provided is prudent and in the best
interest of the participant or beneficiary, and explain to the
participant or beneficiary the basis for the conclusion, including, if
applicable, why and how the advice deviates from or relates to the
computer modeled recommendations or investment education materials
furnished in satisfaction of paragraph (d)(3)(i) or (ii), and why the
advice includes an option(s) with higher fees than other options in the
same asset class(es) available under the plan. Further under paragraph
(d)(6)(ii), not later than 30 days following such explanation, the
employee, agent or registered representative providing the advice on
behalf of the fiduciary adviser must document the explanation. The
final rule, like the proposal, also requires this documentation to be
retained in accordance with the record retention requirements of
paragraph (e) of the final rule. See paragraph (d)(6)(ii)(C) of the
final rule.
f. Use of Fee-Leveling
Paragraph (d)(4) of the final rule addresses the fee-leveling
requirement of the class exemption. As proposed, the class exemption
applied the fee-leveling requirement only to the individuals who
provide the investment advice on behalf of the fiduciary adviser,
namely, employees, agents, and registered representatives. This is in
contrast to the fee-leveling requirement under the statutory exemption,
as described above with respect to paragraph (b) of the final rule,
which applied the fee-leveling requirement at both the entity
(fiduciary adviser)-level and the individual (employee, agent,
registered representative)-level. In this regard, the Department was
persuaded that the additional safeguards provided for in the class
exemption were sufficient to permit the application of the fee-leveling
requirement at the individual-level, rather than fiduciary adviser-
entity level, without compromising the availability of informed,
unbiased, and objective investment advice for participants and
beneficiaries. As explained in the discussion relating to the fee-
leveling provisions of the statutory exemption, some commenters
objected to the limited scope of the fee-leveling requirement and other
commenters requested that the breadth of the fee-leveling requirement
be narrowed. The Department continues to believe it reached the
appropriate balance of protections and flexibility in the proposal and,
accordingly is
[[Page 3837]]
adopting the fee-leveling framework of the proposed class exemption
without modification in the final rule.
g. Policies and Procedures
The proposed exemption contained a requirement that the fiduciary
adviser adopt and follow written policies and procedures that are
designed to assure compliance with the conditions of the exemption. As
explained in the preamble to the proposal, the Department believes that
the maintenance of such policies and procedures will help ensure
compliance with the exemption, as well as support a finding that, for
purposes of section 408(a)(1), the exemption is administratively
feasible. The Department has not changed its view in this regard and,
in the absence of any comments objecting to this provision of the
proposal, is adopting this requirement without change in the final
rule. See paragraph (d)(7). The Department also notes that the auditor
engaged to conduct an audit pursuant to paragraph (d)(9) of the final
rule, discussed earlier, is required, as part of that audit, to review
a fiduciary adviser's compliance with its policies and procedures.
5. Retention of Records
Both the proposed regulation implementing the statutory exemption
and the proposed class exemption had record retention requirements,
with respect to which there were no comments. Paragraph (e) of the
final rule sets forth the record retention requirements now applicable
to both investment advice arrangements relying on the statutory
exemption, as set forth in paragraph (b), and investment advice
provided pursuant to the class exemption, as set forth in paragraph
(d), of the final rule. Paragraph (e) 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.
6. Noncompliance
The proposed class exemption specifically addressed the effects of
noncompliance with the exemption. In this regard, the proposal
explained that the class exemption would not apply to any covered
transaction in connection with the provision of investment advice to an
individual participant or beneficiary with respect to which the
conditions of the exemption have not been satisfied. The proposal also
indicated that, in the case of a pattern or practice of noncompliance
with any of the conditions, the exemption would 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.
Several commenters objected to the ``pattern or practice''
provision, arguing that because non-compliant advice is already subject
to an excise tax under the Code, extending the penalty to all advice
provided during a period, without regard to it being compliant advice,
is unnecessary and punitive. Commenters also argued that the concept of
a ``pattern or practice'' was unclear. Some commenters suggested the
penalty should be prospective only, while others argued there should be
a de minimus rule or period for correcting such noncompliance before
losing the relief of the exemption for compliant advice. On the other
side, one commenter argued that increased penalties for noncompliance
would make the exemption more protective.
The Department believes that one of the most significant deterrents
to noncompliance with the conditions of the statutory and class
exemption is the potentially significant excise taxes applicable to
transactions that fail to satisfy the conditions of the exemptions. The
Department believes that the ``pattern or practice'' provision creates
additional incentives on the part of fiduciary advisers taking
advantage of the exemptive relief to be vigilant in designing and
following policies, procedures and practices that will assure
compliance. The Department, therefore, has retained this provision in
the final rule. Unlike the proposal, however, the provision now applies
to both relief under the statutory exemption and the class exemption.
As revised, paragraph (f) of the final rule provides that: (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 paragraphs (b) and (d) of the final rule 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 the
final rule have not been satisfied; and (2), in the case of a pattern
or practice of noncompliance with any of the applicable conditions of
the final rule, the relief described in paragraph (b) or (d) 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.
With respect to what the Department might view as a ``pattern or
practice'' of noncompliance with the exemptions, 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 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.
7. Effective Date
The Department proposed that the regulation would be effective 60
days after the date of publication of the final rule and that the class
exemption would be effective 90 days after the date of publication of
the final exemption. One commenter suggested that the 60 day effective
date would not constitute sufficient time to comply with the final
rule. One commenter suggested that the final rule should be effective
no earlier than the later of July 1, 2009, or 180 days after
publication of the final rule. Another commenter requested that rule be
made effective upon publication.
Given the importance of investment advice to participants and
beneficiaries generally and given that the exemptions contained in this
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. 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) and (d) of the final rule occurring on or after that date.
8. General Information
The attention of interested persons is directed to the following:
[[Page 3838]]
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and section 4975(c)(2) of the Code does
not relieve a fiduciary or other party in interest or disqualified
person from other provisions of the Act and the Code, including any
prohibited transaction provisions to which the exemption does not apply
and the general fiduciary responsibility provisions of section 404 of
the Act. Section 404 requires, among other things, that a fiduciary
discharge its duties with respect to the plan prudently and solely in
the interests of the plan's participants and beneficiaries. A
transaction's qualification for an exemption also does not affect the
requirement of section 401(a) of the Code that the plan must operate
for the exclusive benefit of the employees of the employer maintaining
the plan and their beneficiaries;
(2) The exemptions contained herein are supplemental to, and not in
derogation of, any other provisions of the Act and the Code, including
statutory or administrative exemptions and transitional rules; and
(3) In accordance with section 408(a) of ERISA and section
4975(c)(2) of the Code, and based on the entire record, the Department
finds that, as discussed above, the class exemption contained in this
document is administratively feasible, in the interests of the plan(s)
and IRAs and of its participants and beneficiaries, and protective of
the rights of the participants and beneficiaries of the plan and IRAs.
C. Overview of Final Sec. 2550.408g-2
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, 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 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 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) of the proposal, 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; and identify the person who is the fiduciary
adviser, the person who develops the computer model or markets the
computer model or investment advice program with respect to the
arrangement, and the person who 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 also 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 plan fiduciary who authorized use of the
arrangement; and that the writing be retained in accordance with the
record retention requirements of Sec. 2550.408g-1(e).
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
1. Summary
In the regulatory impact analysis (RIA) for the proposed regulation
and class exemption (hereafter, ``the proposals''), the Department
noted that, historically, many participants and beneficiaries in
participant-directed defined contribution plans and beneficiaries of
individual retirement accounts (IRAs) (collectively hereafter,
``participants'') have made investment mistakes. The Department
anticipates that full implementation of the PPA under this final
regulation, together with this class exemption (hereafter, the ``final
rule''), by extending quality, expert investment advice to a greater
number of participants will improve investment decisions and results.
This improvement in investment results reflects reductions in
investment errors, including poor trading strategies and inadequate
diversification. The Department further anticipates that the increased
investment advice resulting from the final rule also will reduce
participants' investment related expenses, further improving their
overall investment results, and will improve the welfare of
participants by better aligning participant investments and their risk
tolerances.
The provisions of the final rule are designed to promote the
availability of affordable, quality investment advice.
2. Public Comments
The Department received several comments on the regulatory impact
analysis of the proposals. The following is a summary of the major
comments and the Department's response thereto.
a. Trading Strategies
A number of commenters objected to the Department's contention that
participants' active attempts to ``time the market'' constitute
inferior trading strategies that result in losses. According to these
commenters, the term ``market timing'' ``no longer defines investment
strategies providing investors with enhanced risk-adjusted returns''
and professionals are proficient in actively managing clients'
portfolios. The commenters further asserted that the Department should
not favor one investment strategy over another.
The Department continues to believe that automatic rebalancing is
likely to be superior on average to participants' own efforts (without
benefit of expert advice) to time the market (meaning to reallocate
assets in anticipation of future market movements). However, this says
nothing about the relative merits of active professional account
management. The Department is unaware of any studies that measure the
performance of managed accounts relative to that of target date funds
or other automatic rebalancing arrangements, and proffers no view as to
whether one strategy is superior to another.
[[Page 3839]]
b. Permissible Arrangements
The Department included in its analysis of the proposals a table
summarizing how compensation of fiduciary advisers can vary in advice
arrangements operating under the following three scenarios: Absent any
exemptive relief, pursuant to the PPA statutory exemption, and pursuant
to the proposed class exemption. As requested in comments, the
Department advises that the table was not intended to exhaustively list
all permissible advice arrangements. Some arrangements might operate
pursuant to other exemptive relief. Participants and plans continue to
have the option of obtaining advice under arrangements that were
permitted prior to enactment of the PPA and promulgation of this final
rule. Furthermore, the Department does not favor any particular
permissible arrangement over any other.
c. Preferences for Computer Models v. Contact With Advisers
In response to commenters, the Department is modifying its
assertion that some participants are dissatisfied with advice from
computer models. Rather, the cited authorities indicate that plan
sponsors rate arrangements that include contact with advisers as more
effective than those that rely exclusively on computer models, and
provide some evidence that more participants make use of the former
than the latter.
d. Revenue Sources and Active Marketing
In its analysis of the proposals the Department suggested that
advisers with revenue sources other than level \20\ fees paid directly
by participants, plans or sponsors might market their advisory services
more actively to certain participant market segments than independent
advisers do. Some commenters disputed this suggestion. These commenters
pointed out that independent advisers may receive alternative revenue
sources such as revenue sharing and may not rely exclusively on level
fees, and emphasized that plan sponsors mediate adviser efforts to
market to participants.
---------------------------------------------------------------------------
\20\ ``Level'' in this context means invariant with respect to
associated investment decisions.
---------------------------------------------------------------------------
First, the Department clarifies that in this context
``independence'' was meant to reference exclusive reliance on level
fees rather than a lack of affiliation. Second, the Department notes
that other commenters strongly suggested that alternative sources of
compensation for investment advisory services may facilitate sales of
such services where exclusive reliance on level fees would not--
particularly sales of adviser consultations (as distinct from computer
models alone) to small account holders. Therefore, the Department
continues to believe that some advisers with such alternative sources
of compensation for investment advice services will be more inclined
than independent advisers to market such services to some participant
market segments. Finally, the Department notes that active marketing
could target plan sponsors as well as plan participants and IRA
beneficiaries.
e. Audit Requirement
In response to comments, the Department notes that its assumption
that audits would be outsourced to an independent legal professional
was intended only as a proxy to estimate the cost of compliance with
the audit requirement. In fact, as discussed earlier in the preamble,
the Department is not persuaded that there is necessarily one set of
credentials, such as experience as certified public account or auditor
or lawyer, that, in and of itself, qualifies an individual or
organization to conduct the audits required by the statutory and class
exemptions. Likewise, the Department's assumptions regarding the sample
of transactions to be audited were adopted for purposes of cost
estimation and should not be construed as guidance as to how sampling
should be conducted. Having said that, the assumptions are consistent
with compliant sampling at the level of the financial institution
acting as the fiduciary adviser.
f. Advice Quality
The Department's RIA of the proposals devoted considerable
attention to the question of whether adviser conflicts might taint
advice. As detailed there, there is evidence to suggest that conflicted
advisers sometimes reap profit at investors' expense. The proposals'
conditions were intended to prevent conflicts from tainting advice.
Accordingly, the RIA assumed that advice arrangements operating
pursuant to the proposals would be as effective as arrangements
operating without need for exemptive relief, notwithstanding the
conflicts that are attendant to the former.
As noted earlier in this preamble, some commenters maintained that
the proposals' conditions, together with the threat of substantial
excise tax penalties for noncompliance, are sufficiently protective and
that consequently advice provided pursuant to the proposals will be of
high quality and reflect the participants' best interests. The
Department can be confident that advice arrangements operating pursuant
to the proposals will satisfy the applicable conditions because
advisers are scrupulous about compliance, the commenters said. Some of
these commenters suggested that some of the conditions were more
stringent than necessary and should be relaxed. For example, some
commenters objected to the proposed condition denying exemptive relief
to all transactions under an arrangement where there is a pattern or
practice of failures to satisfy applicable conditions. Relief should be
denied only to particular transactions for which conditions were not
satisfied, the commenters said. Some commenters argued that the
proposals' limits on compensation that can be paid under level fee
arrangements should be relaxed to permit certain types of performance
based rewards, bonuses and promotions.
Also as noted earlier in this preamble, other commenters questioned
the Department's assumption that advice arrangements operating pursuant
to the proposals would be as effective as arrangements operating
without need for exemptive relief, predicting that the former will too
often be tainted by attendant conflicts. Most of these commenters
expressed deepest concern with the proposed class exemption, arguing
that the fiduciary adviser and the person providing the advice may be
conflicted. Some commenters also expressed concern with the proposed
regulation's interpretation of the statutory exemption, arguing that
the fiduciary advisers' affiliates may be conflicted. These commenters
maintained that the proposals' conditions are not sufficiently
protective. Persons providing advice on behalf of fiduciary adviser
entities cannot be fully insulated from conflicts affecting the
entities or their affiliates, the commenters said, and the proposals'
procedural safeguards, including disclosure and independent audits,
together with available enforcement mechanisms, are not sufficient to
ensure compliance with the proposals' substantive conditions, such as
unbiasedness and adherence to investment theories. Some commenters
cautioned that investors are vulnerable to manipulation.
The Department continues to believe, as it did in connection with
the proposals, that, in the absence of adequate protections, an
adviser's conflicts may result in biased advice.\21\
[[Page 3840]]
However, the Department also believes that the safeguards included in
this final rule, together with associated enforcement mechanisms
including the potentially significant excise taxes \22\ for
noncompliance and for patterns and practice of noncompliance,
effectively minimize the possibility that fiduciary advisers will act
on their conflicts. Provisions expected to deter noncompliance include
the annual audit requirement, disclosure of noncompliant activities
identified in the course of an audit to authorizing plan fiduciaries
and, in the case of IRAs, to the Department, and the pattern or
practice provision.
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\21\ Since promulgating the proposals the Department has
considered additional evidence suggesting that adviser conflicts can
taint advice. See, e.g., U.S. SEC, Protecting Senior Investors:
Report of Examinations of Securities Firms Providing ``Free Lunch''
Sales Seminar (Sept. 2007).
\22\ Under Code section 4975, fiduciaries participating in
prohibited transactions may be subject to an excise tax of 15
percent of the amount involved for each year in the taxable period,
in addition to which an excise tax of 100 percent of the amount
involved may be added depending on whether the prohibited
transactions are timely corrected.
---------------------------------------------------------------------------
Because the conditions and enforcement mechanisms constitute
adequate safeguards, the Department believes that any impact of
conflicts on advice provided pursuant to the statutory and class
exemptions will be minimal. The Department stands by its assumption
that advice arrangements operating pursuant to the final rule will be
as effective as arrangements operating without need for exemptive
relief.
g. Effect on 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.
In its RIA of the proposals, the Department estimated that fees and
expenses paid by unadvised participants are higher than necessary by
11.3 basis points on average. Some commenters on the proposals, as well
as some commenters on the Department's proposed regulation governing
disclosure to participant-directed defined contribution (DC) plan
participants,\23\ disputed this estimate. The commenters pointed to
evidence that the pricing of investment products and related services
is competitive and efficient, and contended that there is no credible
evidence to the contrary.
---------------------------------------------------------------------------
\23\ See 73 FR 43013 (July 23, 2008).
---------------------------------------------------------------------------
The commenters raised several specific challenges to the
Department's analysis. First, they contended that the Department's
estimate relies inappropriately on dispersion in mutual fund expenses
as evidence that such expenses are sometimes higher than necessary and
as a basis for estimating the degree to which this is so. Dispersion in
expenses reflects differences among the investment products or the
services bundled with them, the commenters said, and therefore such
dispersion is consistent with competitive, efficient pricing. Second,
the commenters argued that the analysis draws incorrect inferences
about fees and expenses in DC plans. The analysis overlooks the role of
DC plan fiduciaries in choosing reasonably priced investments and
relies too much on research that examined retail rather than DC plan
experience, they said. Third, the commenters highlighted what they say
are technical flaws in some of the research that the Department had
cited as supporting the conclusion that fees and expenses are sometimes
higher than necessary, and they took issue with the Department's
interpretation of some of the research.
In response to these commenters, the Department undertook to refine
and strengthen its analysis. First, the Department agrees that the RIA
of the proposals relied too heavily on mere dispersion of fees and
expenses as a basis for estimating whether and to what degree they
might be higher than necessary. The estimate that they are on average
11.3 basis points higher than necessary lacks adequate basis and should
be disregarded. Second, the Department agrees that fees and expenses
paid by DC plan participants can differ from those paid by retail
investors. Any evidence of higher than necessary expenses in the retail
sector might suggest similar circumstances in DC plans, but would not
demonstrate it. Third, the Department reviewed available research
literature in light of the commenters, and refined its analysis and
conclusions accordingly, as summarized immediately below.
(i) Expense sensitivity--Surveys and studies strongly suggest gaps
in awareness of and sensitivity to expenses.\24\ Other studies consider
whether investors with different levels of sophistication make
different decisions about fees. If more sophisticated investors are
more sensitive to fees, less sophisticated ones might be paying more
than would be optimal. Alternatively, they might be paying more in
order to obtain sophisticated help. Much literature suggests a negative
relationship between sophistication and expenses paid,\25\ but some
does not.\26\ Overall this literature leaves open the question of
whether investment prices are sometimes inefficiently high, but
suggests that even if prices are efficient investors may make poor
purchasing decisions. The Department believes that many individual
investors, including both DC plan participants and IRA beneficiaries,
[[Page 3841]]
historically have not factored expenses optimally into their investment
choices.
---------------------------------------------------------------------------
\24\ See e.g., James J. Choi et al., Why Does the Law of One
Price Fail? An Experiment on Index Mutual Funds, National Bureau of
Economic Research Working Paper W12261 (May 2006); Jeff Dominitz et
al., How Do Mutual Funds Fees Affect Investor Choices? Evidence from
Survey Experiments (May 2008) (unpublished, on file with the
Department) (Dominitz); and John Turner & Sophie Korczyk, Pension
Participant Knowledge About Plan Fees, AARP Pub ID: DD-105 (Nov.
2004). Commenters pointed out that net flows are concentrated in
mutual funds with low expenses. However it is unclear whether this
reflects investor fee sensitivity or brand name recognition and
successful marketing by large, established funds whose low fees are
attributable to economies of scale.
\25\ Sebastian M[uuml]ller & Martin Weber, Financial Literacy
and Mutual Fund Investments: Who Buys Actively Managed Funds?,
Social Science Research Network Abstract 1093305 (Feb. 14, 2008)
found that more financially literate investors pay lower front-end
loads but similar management fees, and suggest that investors who
know about management fees appear not to care about them. Dominitz
finds that financially literate individuals are better able to
estimate fees, and better estimates are associated with more optimal
investment choices. Brad M. Barber et al., Out of Sight, Out of
Mind, The Effects of Expenses on Mutual Fund Flows, Journal of
Business, Volume 79, Number 6, 2095-2119 (2005) found that repeat
investors are more sensitive to load fees than expense ratios, but
commenters point out that this finding may be an artifact of
industry load setting practices.
\26\ Mark Grinblatt et al., Are Mutual Fund Fees Competitive?
What IQ-Related Behavior Tells Us, Social Science Research Network
Abstract 1087120 (Nov. 2007) found that investors with different IQs
pay similar fees, which ``suggests that fees are set
competitively.''
---------------------------------------------------------------------------
(ii) Sector differences--Some studies lend insight to the question
of whether investment prices are efficient by comparing prices paid or
performance in different market segments.\27\ The Department believes
that taken together, this literature suggests that there are
unexplained differences in prices and performance across sectors but
fails to demonstrate conclusively whether such differences are
systematically attributable to inefficiently high investment prices.
(iii) Market power--At least one study suggests that mutual funds
may wield market power to mark up prices to inefficient levels.\28\
---------------------------------------------------------------------------
\27\ John P. Freeman & Stewart L. Brown, Mutual Fund Advisory
Fees: The Cost of Conflicts of Interest, The Journal of Corporate
Law, Volume 26, 609-673 (Spring 2001), found that the price paid by
mutual funds for equity fund management is higher than that paid by
pension funds. Based on this and other evidence they argue that
mutual fund fees are often excessive. John C. Coates & R. Glenn
Hubbard, Competition in the Mutual Fund Industry: Evidence and
Implications for Policy, Social Science Research Network Abstract
1005426 (Aug. 2007), challenged Freeman and Brown's methods and
conclusions, arguing that these differences in prices are
attributable to differences in services for which Freeman and Brown
did not account. They offer evidence that fees are competitive.
Alicia H. Munnell et al., Investment Returns: Defined Benefits vs.
401(k) Plans, Center for Retirement Research Issue Brief Number 52
(Sept. 2006), found higher returns in defined benefit (DB) plans
than in DC plans and offered that ``part of the explanation may rest
with higher fees'' that are paid by DC plan participants. Rob Bauer
& Rik G.P. Frehen, The Performance of U.S. Pension Funds, Social
Science Research Network Abstract 965388 (Jan. 2008), found that DC
and DB plans both perform close to benchmarks while mutual funds
underperform, and point to hidden costs in mutual funds as the most
likely reason. Diane Del Guercio & Paula A. Tkac, The Determinants
of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension
Funds, The Journal of Financial and Quantitative Analysis, Volume
37, Number 4, 523-557 (Dec. 2002), found that ``in contrast to
mutual fund investors, pension clients punish poorly performing
managers by withdrawing assets under management and do not flock
disproportionately to recent winners.''
\28\ Guo Ying Luo, Mutual Fund Fee-Setting, Market Structure and
Mark-Ups, Economica, Volume 69, Number 274, 245-271 (May 2002),
exploited differences in market concentration across different
narrow mutual funds categories, and found that mark-ups average 30
percent of fees across all categories of no load funds and more than
70 percent across load funds (assuming a 5-year holding period).
---------------------------------------------------------------------------
(iv) What expenses buy--A number of studies considered the degree
to which expense dispersion is a function of product features and
bundled services, and if it is, whether that dispersion is justified by
differences in observable attendant financial benefits such as
performance. Some of this literature also considered the degree to
which investors choose investments where expenses are so justified. In
the Department's view this literature taken together suggests that a
substantial portion of expense dispersion is attributable to
distribution expenses, including compensation of intermediaries and
advertising.\29\ It casts doubt on whether such expenses are duly
offset by observable financial benefits. Most studies are consistent
with the possibility that such expenses are at least partly offset by
unobserved benefits such as reduced search costs and other support for
novice and unsophisticated investors, but most are also consistent with
the possibility that some expenses are not so offset and that
investors, especially unsophisticated ones, sometimes pay inefficiently
high prices.\30\ The authors of some studies expressly interpreted
their failure to identify offsetting financial benefits as evidence
that prices are inefficiently high. Some suggested that conflicted
intermediaries may serve their own and fund managers' interests,
thereby generating inefficiently high profits for either or both.
Others disagreed, believing that investors efficiently derive a
combination of financial and intangible benefits for their expense
dollars.\31\
---------------------------------------------------------------------------
\29\ The literature also attributed much expense dispersion to
differences in the cost of managing different types of funds. For
example, active equity management is more expensive than passive and
management of foreign or small cap equity funds is more expensive
than management of large cap domestic equity funds. Investors
therefore might optimally diversify across funds with different
levels of investment management expense. Some studies questioned
whether active management delivers observable financial benefits
commensurate to the associate expense. For example, Kenneth R.
French, The Cost of Active Investing, Social Science Research
Network Abstract 1105775 (Apr. 2008), found that investors spend
0.67 percent of aggregate U.S. stock market value each year
searching for superior return, and characterized this as society's
cost of price discovery.
\30\ Both of these hypotheses are also consistent with
literature finding a negative link between sophistication and
expenses.
\31\ The following is a sampling of findings and interpretations
reported in various studies that the Department reviewed. The
Department observes that some of these studies have been published
in peer-reviewed journals, while others have not. Some are working
papers subject to later revision. Some research is visibly supported
by industry or other interests, and some may be independent. Very
little of this research separately examines DC plan investing.
Nearly all of it examines mutual fund markets to the exclusion of
certain competing insurance company or bank products. Some of it
examines foreign experience. The Department believes it must be
cautious in drawing inferences from this research as to whether
investment prices paid by participants are efficient.
Daniel B. Bergstresser et al., Assessing the Costs and Benefits
of Brokers in the Mutual Fund Industry, Social Science Research
Network Abstract 616981 (Sept. 2007), found that investors who pay
to purchase funds via intermediaries realize inferior returns, and
said this result is consistent with either intangible benefits for
investors or inefficiently high prices due to conflicts.
Ralph Bluethgen et al., Financial Advice and Individual
Investors' Portfolios, Social Science Research Network Abstract
968197 (Mar. 2008), found that advisers (who are mostly compensated
by commission) improve diversification and allocation across classes
while increasing fees and turnover. They said these findings are
consistent with ``honest advice.''
Mercer Bullard et al., Investor Timing and Fund Distribution
Channels, Social Science Research Network Abstract 1070545 (Dec.
2007), found that investors who transact through conflicted advisers
incur timing underperformance.
Susan Christoffersen et al., The Economics of Mutual-Fund
Brokerage: Evidence from the Cross Section of Investment Channels,
Science Research Network Abstract 687522 (Dec. 2005), identified
some financial benefits reaped by investors who pay to invest
through intermediaries.
Sean Collins, Fees and Expenses of Mutual Funds, 2006,
Investment Company Institute Research Fundamentals, Volume 16,
Number 2 (June 2007), reported that mutual fund fees and expenses
are declining.
Sean Collins, Are S&P 500 Index Mutual Funds Commodities?,
Investment Company Institute Perspective, Volume 11, Number 3 (Aug.
2005), argued that S&P 500 index funds are not uniform commodities.
For example, they are distributed in different ways. He found that
91 percent of the variation in these funds' expense ratios can be
explained by a combination of fund asset size, investor account
size, fee waivers and separate fees, and investor advice that is
bundled into expense ratios. He argued that these funds
competitively pass economies of scale along to investors, and
reported that assets and flows are concentrated in low-cost funds.
Henrik Cronqvist, Advertising and Portfolio Choice, Social
Science Research Network Abstract 920693 (July 26, 2006), found that
fund advertising steered investors toward ``portfolios with higher
fees, more risk, more active management, more `hot' sectors, and
more home bias.'' He suggested that ``with the use of advertising,
funds can differentiate themselves and therefore charge investors
higher fees than the lowest-cost supplier in the industry.''
Daniel N. Deli, Mutual Fund Advisory Contracts: An Empirical
Investigation, The Journal of Finance, Volume 57, Number 1, 109-133
(Feb. 2002), found that differences in investment advisers' marginal
compensation reflected differences in their marginal product,
difficulty in measuring adviser performance, control environments,
and scale economies. Based on this finding, he suggested that
investment prices are efficient and recommended caution in any
regulatory effort to influence such prices.
Edwin J. Elton et al., Are Investors Rational? Choices Among
Index Funds, The Journal of Finance, Volume 59, Number 1, 261-288
(Feb. 2004), found that flows into high-expense (and therefore
predictably low performance) S&P 500 index mutual funds were higher
than would be expected in an efficient market. They concluded that,
because investors are not perfectly informed and rational, inferior
products can prosper. Commenters, however, contended that, because
the authors scaled flows by fund size and smaller funds have higher
expenses, these findings exaggerated the degree to which flows are
directed to high-expense funds.
Javier Gil-Bazo & Pablo Ruiz-Verd[uacute], Yet Another Puzzle?
Relation Between Price and Performance in the Mutual Fund Industry,
Social Science Research Network Abstract 947448 (March 2007), found
that ``funds with worse before-fee performance charge higher fees.''
They hypothesized that lower-performing funds lose sophisticated
investors to higher performing funds, then are left with relatively
unsophisticated investors who are not as responsive to price.
John A. Haslem et al., Performance and Characteristics of
Actively Managed Retail Equity Mutual Funds with Diverse Expense
Ratios, Financial Services Review, Volume 17, Number 1, 49-68
(2008), found that funds with lower expenses have superior returns.
John A. Haslem et al., Identification and Performance of Equity
Mutual Funds with High Management Fees and Expense Ratios, Journal
of Investing, Volume 16, Number 2 (2007), found that certain
performance measures vary negatively with fees and, on that basis,
suggested that mutual funds do not compete strongly on price and
that expenses are too high.
Sarah Holden & Michael Hadley, The Economics of Providing 401(k)
Plans: Services, Fees and Expenses 2006, Investment Company
Institute Research Fundamentals, Volume 16, Number 4 (Sept. 2007),
reported that 401(k) mutual fund investors tended to pay lower than
average expenses and that 401(k) assets were concentrated in low-
cost funds.
Ali Hortacsu & Chad Syverson, Product Differentiation, Search
Costs, and Competition in the Mutual Fund Industry: A Case Study of
S&P 500 Index Funds, Quarterly Journal of Economics, 403 (May 2004),
documented dispersion in S&P 500 Index Fund expense ratios, and
reported that low-cost funds had a dominant, but falling, market
share. They concluded that an influx of novice investors who must
defray search costs explained dispersion in expenses and flows to
high-expense funds.
Todd Houge & Jay W. Wellman, The Use and Abuse of Mutual Fund
Expenses, Social Science Research Network Abstract 880463 (Jan.
2006), found that load funds charge higher 12b-1 and management
fees. They attributed this to abusive market segmentation that
extracted excessive fees from unsophisticated investors.
Giuliano Iannotta & Marco Navone, Search Costs and Mutual Fund
Fee Dispersion, Social Science Research Network Abstract 1231843
(Aug. 2008), analyzed the effect of search costs on mutual fund fees
with data on broad U.S. domestic equity funds. They estimated the
portion of the expense ratio that was not justified by the quality
of service provided, by the cost structure of the investment
company, or by the specificities of the clientele served by the fund
and found that its dispersion was lower for highly visible funds and
for funds that invested heavily in marketing. In the case of the
U.S. mutual fund market, they argued, the dispersion of this
residual demonstrated the extent to which some firms can charge a
``non-marginal'' (that is higher than competitive) price.
Marc M. Kramer, The Influence of Financial Advice on Individual
Investor Portfolio Performance, Social Science Research Network
Abstract 1144702 (Mar. 2008), found that advised investors took less
risk and thereby reaped lower returns. Risk-adjusted performance was
similar. Adjusting further for investor characteristics, advised
investors performed slightly worse.
Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund
Flows, The Journal of Finance, Volume 53, Number 5, 1589-1622 (Oct.
1998), found that investors were ``fee sensitive in that lower-fee
funds and funds that reduce fees grow faster.'' Investors' fee
sensitivity was not symmetric, however.
Edward Tower & Wei Zheng, Ranking Mutual Fund Families: Minimum
Expenses and Maximum Loads as Markers for Moral Turpitude, Social
Science Research Network Abstract 1265103 (Sept. 2008), found a
negative relationship between expense ratios and gross performance.
The Division of Investment Management: Report on Mutual Fund Fees
and Expenses, U.S. Securities and Exchange Commission (Dec. 2000),
at http://www.sec.gov/news/studies/feestudy.htm, described mutual
fund fees and expenses and identified major factors that influenced
fee levels but did not assess whether prices were efficient.
Xinge Zhao, The Role of Brokers and Financial Advisors Behind
Investment Into Load Funds, China Europe International Business
School Working Paper (Dec. 2005), at http://www.ceibs.edu/faculty/zxinge/brokerrole-zhao.pdf, found that funds with higher loads
received higher flows, and suggested that conflicted intermediaries
enriched themselves at investors' expense.
---------------------------------------------------------------------------
[[Page 3842]]
In light of this literature and public commenters, the Department
believes that the available research provides an insufficient basis to
confidently determine whether or to what degree participants pay
inefficiently high investment prices. 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 these actions to reduce that inefficiency. This would increase
participants' welfare by transferring surplus from producers of
investment products and services to them and by reducing 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, they buy investment products and
services whose marginal cost exceed the associated marginal benefit to
them.\32\
---------------------------------------------------------------------------
\32\ It is possible that the converse could sometimes occur:
participants might fail to buy efficiently priced products and
services whose marginal cost lags the associated marginal benefit to
them. In that case advice, by correcting this error, might lead to
higher expenses, but would still improve welfare. Because research
suggests that participants are insensitive to fees rather than
excessively sensitive to them, the Department believes that this
converse situation is likely to be rare.
---------------------------------------------------------------------------
The Department expects these actions to reduce such investment
errors, improving participant and societal welfare. However, the
Department has no basis on which to quantify such errors or
improvements.
3. Impact Assessment
Although the Department anticipates that these actions will
increase the availability of investment advice to DC plan participants
and the use of advice by IRA beneficiaries, the Department is uncertain
how changing market conditions might affect the incidence and magnitude
of investment errors, as well as the availability, use, and effect of
investment advice. Recent developments in financial markets and in the
market for financial products and services underscore this uncertainty.
However, given that the costs of this regulation are due to the cost of
providing (or paying for) investment advice, it will be incurred only
to the extent that participants seek advice and anticipate improved
returns on their investments. Thus, the Department remains confident
that these actions will yield positive net benefits though we are
uncertain of the magnitude. The Department believes that the approach
used in the analysis for the proposed rule could reflect the long-term
effects of these actions and can be viewed as a reasonable upper bound.
The Department's assumptions are summarized in Tables 1, 2, and 3.
Table 1--Availability of Advice to DC Plan Participants
------------------------------------------------------------------------
Any advice
Policy context (computer Live
or live) adviser
------------------------------------------------------------------------
Pre-PPA....................................... 40% 20%
PPA........................................... 50 25
Class exemption............................... 60 35
------------------------------------------------------------------------
Note: There are approximately 66 million DC participants.
Table 2--Number of Entities
------------------------------------------------------------------------
Pre PPA PPA CE
------------------------------------------------------------------------
DC:
Plans offering (000s).............. 209.46 261.82 314.19
Participants offered (MM).......... 26.44 33.05 39.66
Participants using (MM)............ 6.61 8.26 10.25
IRA:
IRAs using (MM).................... 16.81 25.47 33.97
------------------------------------------------------------------------
[[Page 3843]]
Table 3--Use of Advice by DC Plan and IRA Participants
----------------------------------------------------------------------------------------------------------------
Share of participants Dollars advised ($ trillions)
advised ---------------------------------------------------
--------------------------
Policy context DC plans
-------------------------- IRA DC plans IRAs Combined
Where
offered Overall
----------------------------------------------------------------------------------------------------------------
Pre-PPA........................... 25% 10% 33% $0.30 $1.40 $1.70
PPA............................... 25 13 50 0.30 2.10 2.50
Class exemption................... 26 16 67 0.40 2.80 3.20
----------------------------------------------------------------------------------------------------------------
Note: There are approximately 66 million DC participants and approximately 51 million IRA beneficiaries.
As in its RIA of the proposals, the Department assumes here that
advised participants make investment errors at one-half the rate of
unadvised participants. The remaining errors reflect participant
failures to follow advice, together with possible flaws in some advice.
Advice arrangements operating without need for exemptive relief,
pursuant to the PPA statutory exemption, and pursuant to the class
exemption are equally effective on average, the Department assumes.
The Department expects the PPA as implemented by this regulation,
together with this class exemption, to reduce investment errors to the
benefit of participants. The Department's estimates of investment
errors and reductions from investment advice are summarized in Table 4.
Table 4--Long Term Investment Errors and Impact of Advice
[$ billions, annual]
------------------------------------------------------------------------
Errors eliminated by
Remaining advice
Policy context errors -------------------------
Incremental Cumulative
------------------------------------------------------------------------
No advice........................ $115 $0 $0
Pre-PPA advice only.............. 101 14 14
PPA.............................. 95 7 20
Class exemption.................. 88 7 27
------------------------------------------------------------------------
In the RIA of the proposals, the Department estimated costs of $1.8
billion for advice arrangements operating under the PPA statutory
exemption and $2.3 billion for advice arrangements under the class
exemption. As the requirement to document and keep records on the basis
of advice provided under the class exemption was broadened, costs of
about $610 million were added to the costs of the class exemption,
leading to a new estimate of $2.9 billion. The current cost estimates
are summarized in Table 5.
Table 5--Cost of Advice
------------------------------------------------------------------------
Class
Pre-PPA PPA exemption
------------------------------------------------------------------------
Incremental
Advice cost ($ billions)..... $3.80 $1.80 $2.90
Advice cost rate (bps, average).. 23 23 37
Cumulative (combined with
policies to the left)
Advice cost ($ billions)..... $3.80 $5.60 $8.50
Advice cost rate (bps, 23 23 26
average)....................
------------------------------------------------------------------------
4. Alternatives
In formulating this final rule, the Department considered several
alternative approaches, which it detailed in its RIA of the proposals.
The Department in these final actions did not adopt any of the
alternatives discussed in its RIA of the proposals, having received no
sufficiently persuasive comments suggesting that it should. Some public
commenters on the proposals suggested alternatives the Department had
not yet considered. The furthest reaching commenters, expressing
concern that conflicts permitted under the proposals would taint
advice, suggested that the Department should either withdraw the
proposals or modify them to require stricter and/or broader fee
leveling. As detailed above, the Department believes these actions'
conditions are sufficiently protective to safeguard the quality of
advice. Accordingly, the Department did not pursue these alternatives.
Other commenters suggested more incremental revisions to the proposals.
The Department's decisions whether to adopt these suggestions are
discussed earlier in this preamble.
5. Uncertainty
As previously stated, the Department is uncertain how changing
market conditions might affect the incidence and magnitude of
investment errors, as well as the availability, use, and effect of
investment advice. Recent developments in financial markets and in the
market for financial products and
[[Page 3844]]
services underscore this uncertainty. On one hand, falling account
balances might reduce the magnitude of both investment errors and
potential gains from corrective advice. On the other hand, volatility
and losses in financial markets might amplify these, and might increase
plan sponsors' propensity to make advice available and participants'
propensity to seek and follow advice. At the same time, restructuring
and consolidation among suppliers of financial products and services
might alter the cost and availability of advice. The Department intends
its quantitative estimates to reflect the long-term effects that will
encompass a variety of market circumstances. The literature and
experience underlying the Department's estimates reflect a variety of
historical market contexts and conditions. However, given the
uncertainty, we now present the estimate as a plausible upper bound for
the possible effects.
Regardless, the Department remains highly confident in its
conclusion expressed in its RIA of the proposals that investment errors
are common and often large, producing large avoidable losses (including
foregone earnings) in the long run for participants. It likewise
remains confident that participants can reduce errors substantially by
obtaining and following good advice. Public comments on the proposals
reinforce these conclusions.
The Department also remains confident that these actions, by
relaxing rules governing arrangements under which advice can be
delivered, will promote wider use of advice. 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 class exemption would change in response to alternative
assumptions regarding the availability, use, and quality of advice.
Table 6 summarizes the results of these tests.
Table 6--Uncertainty in Estimate of Investment Error Reduction
[$ billions annually]
----------------------------------------------------------------------------------------------------------------
Impact of
Scenarios Impact of class Impact of Remaining
PPA exemption all advice errors
----------------------------------------------------------------------------------------------------------------
Advice eliminates:
75% of errors........................................... $10 $10 $43 $80
50% of errors........................................... 7 7 27 88
25% of errors........................................... 3 3 13 96
After PPA/class exemption, advice reaches:
15%/21% of DC and 60%/80% of IRA........................ 11 8 33 82
13%/16% of DC and 50%/67% of IRA........................ 7 7 27 88
11%/13% of DC and 40%/50% of IRA........................ 3 4 20 95
----------------------------------------------------------------------------------------------------------------
The Department remains uncertain whether the magnitude and
incidence of investment errors and the potential for correction of such
errors in the context of IRAs might differ from that in the context of
ERISA-covered DC plans. If a DC plan's menu of investment options is
efficient then the incidence and/or magnitude of errors might be
smaller than in the IRA context. If it is inefficient then errors might
be more numerous and/or larger, but the potential for correcting them
might be constrained. Commenters that address this issue mostly suggest
that menus are efficient.
The Department remains 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. As
discussed above, comments on these questions are mixed and provide no
basis for the Department to revise its baseline assumption that all
arrangements will be equally effective.
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. The
Department's concern over this uncertainty is modest because commenters
on the proposals emphasize the industry's willingness to comply with
these actions' conditions and the benefits to investors of implementing
sound recommendations.
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 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 lacks bases to estimate include financial market
impacts of changes in investor behavior and related macroeconomic
effects.
However, given that the costs of this regulation are due to the
cost of providing (or paying for) investment advice, it will be
incurred only to the extent that participants seek advice and
anticipate improved returns on their investments. Thus, the Department
remains confident that these actions will yield positive net benefits
though we are uncertain of the magnitude.
E. Executive Order 12866
Under Executive Order 12866, the Department must determine whether
a regulatory action is significant and therefore subject to the
requirements of the Executive Order and review by the Office of
Management and Budget (OMB). This action, comprising this final rule,
is economically significant under section 3(f)(1) of the Executive
Order because it is likely to have an effect on the economy of $100
million or more in any one year. Accordingly, the Department undertook
the foregoing analysis of the action's impact. On that basis the
Department believes that the action's benefits justify its costs.
[[Page 3845]]
F. Regulatory Flexibility Act
In the notice of proposed rulemaking, the Department certified that
the proposed regulation, if adopted, would not have a significant
economic impact on a substantial number of small entities. For purposes
of the analysis, the Department proposed to continue its usual practice
of considering a small entity to be an employee benefit plan with fewer
than 100 participants. The Department consulted with the Small Business
Administration Office of Advocacy concerning use of this participant
count standard for Regulatory Flexibility Act purposes and requested
public commenters on this issue. The Department did not receive any
comments that address its use of the participant count standard and
continues to consider a small entity to be an employee benefit plan
with fewer than 100 participants.
The Department received a comment from a small investment advisory
firm that provides investment management services to IRA beneficiaries.
The commenter expressed concern that it will incur substantial cost to
comply with the PPA's statutory exemption in order to continue
providing investment advisory services for its IRA clients. The
Department observes, however, that investment advice arrangements that
were permissible before enactment of the PPA remain permissible without
respect to whether they satisfy the conditions of the PPA's statutory
exemption. Therefore the Department does not detect in this comment
evidence of a substantial impact on a small entity.
Another commenter stated that small plan sponsors will bear an
additional fiduciary burden under the statutory exemption, because it
allows them to enter into investment advice arrangements with
conflicted fiduciary advisers. Therefore, the commenter opined, the
Department should have completed an Initial Regulatory Flexibility
Analysis when proposing the regulation. The Department notes, however,
that the permissibility of such arrangements is established by statute
and not by this implementing regulation. The Department also notes that
small plan sponsors remain free to enter into advice arrangements that
are free from conflicts. Therefore the Department does not detect in
this comment evidence of a substantial impact on a significant number
of small entities.
In light of the foregoing, the Department hereby certifies that the
final rule will not have a significant impact on a substantial number
of small entities.
G. 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.
H. 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.
I. 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.
J. 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 commenters 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.
No public comments were received that specifically addressed the
paperwork burden analysis of the information collections.
The Department submitted an ICR to OMB for its request of a new
information collection. OMB approved the ICR on January 9, 2009, under
OMB Control Number 1210-0134, which will expire on January 31, 2012.
In order to use the statutory exemption and/or the class exemption
to provide investment advice to participants and beneficiaries in
participant-directed DC plans and beneficiaries of IRAs (collectively
hereafter, ``participants''), investment advisory firms are required to
make disclosures to participants and hire an independent auditor to
conduct a compliance audit and issue an audit report every year.
Investment advice firms following the conditions of the exemption based
on disclosure of computer model-generated investment advice are
required to obtain certification of the model from an eligible
investment expert. The class exemption conditions its relief on
establishing written policies and procedures, and both exemptions
impose recordkeeping requirements. These paperwork requirements are
designed to safeguard the interests of participants in connection with
investment advice covered by the exemptions.
The calculation of the estimated hour and cost burden of the ICRs
under the statutory and class exemption were discussed in detail in the
NPRM and are summarized below.\33\
---------------------------------------------------------------------------
\33\ Changes made to the disclosure requirements in the final
rule are specifically identified below. In addition to the
disclosure requirements contained in the NPRM, the final statutory
and class exemption provide that, if a computer model does not make
recommendations with respect to investment options that constitute
certain investment funds, products, or services, the fiduciary
adviser must provide the participant or beneficiary with information
explaining such funds, products, or services when the investment
advice generated by the computer model is presented. For purposes of
this analysis, the Department assumes that this information is
readily available to the fiduciary advisor and will not necessarily
have to be given to the participant in paper form. Therefore, no
additional paperwork burden was added. The numbers presented also
reflect a very minor update of the number of DC plan participants
utilizing advice.
---------------------------------------------------------------------------
1. Final Statutory Exemption Hour and Cost Burden
The Department estimates that the third-party disclosures, computer
model certification, and audit requirements for
[[Page 3846]]
the final statutory exemption will require approximately 4.0 million
burden hours with an equivalent cost of approximately $416.8 million
and a cost burden of approximately $579.4 million in the first year. In
each subsequent year the total labor burden hours are estimated to be
approximately 2.1 million hours with an equivalent cost of
approximately $215.6 million and the cost burden is estimated at
approximately $430.1 million per year.
2. Final Class Exemption Hour and Cost Burden
The Department estimates that the third-party disclosures, the
written policies and procedures, and the recordkeeping and audit
requirements for the final class exemption will require a total of
approximately 12.1 million burden hours with an equivalent cost of
approximately $991.3 million and a total cost burden of approximately
$63.2 million in the first year. In each subsequent year, the total
burden hours are estimated at approximately 11.4 million hours with an
equivalent cost of approximately $905.6 million and a total cost burden
of approximately $63.2 million per year.
These numbers include an additional 7.7 million burden hours ($610
million in equivalent costs) in all years due to the extension in the
final class exemption of the requirement that fiduciary advisers in
arrangements using fee-leveling conclude that the provided advice is in
the best interest of the participant or beneficiary, explain the basis
of this conclusion, document the explanation within 30 days, and retain
the documentation. Under the proposed class exemption, this requirement
only applied to arrangements involving post-computer model or post-
investment education investment advice.
3. Overall Exemption Hour and Cost Burden
The Department estimates that the third-party disclosures, the
computer model certification, the written policies and procedures, and
the recordkeeping and audit requirements for the statutory and class
exemptions require approximately 16.1 million burden hours with an
equivalent cost of approximately $1.41 billion and a cost burden of
approximately $642.6 million in the first year. The labor burden hours
in each subsequent year are approximately 13.5 million hours with an
equivalent cost of approximately $1.12 billion and the cost burden in
each subsequent year is approximately $493.3 million per year. These
paperwork burden estimates are summarized as follows:
Type of Review: New collection (Request for new OMB Control
Number).
Agency: Employee Benefits Security Administration, Department of
Labor.
Titles: (1) Proposed Class Exemption for the Provision of
Investment Advice to Participants and Beneficiaries of Self-Directed
Individual Account Plans and IRAs, and (2) Proposed Investment Advice
Regulation.
OMB Control Number: 1210-NEW.
Affected Public: Business or other for-profit.
Estimated Number of Respondents: 16,000.
Estimated Number of Annual Responses: 20,789,000.
Frequency of Response: Initially, Annually, Upon Request, when a
material change.
Estimated Total Annual Burden Hours: 16,126,000 hours in the first
year; 13,504,000 hours in each subsequent year.
Estimated Total Annual Burden Cost: $642,552,000 for the first
year; $493,253,000 for each subsequent year.
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Exemptions, Fiduciaries, Investments,
Pensions, Prohibited transactions, Reporting and recordkeeping
requirements, and Securities.
0
For the reasons set forth in the preamble, the Department amends
Chapter XXV, subchapter F, part 2550 of Title 29 of the Code of Federal
Regulations as follows:
SUBCHAPTER F--FIDUCIARY RESPONSIBILITY UNDER THE EMPLOYEE RETIREMENT
INCOME SECURITY ACT OF 1974
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. 1-
2003, 68 FR 5374 (Feb. 3, 2003). Sec. 2550.401b-1 also issued under
sec. 102, Reorganization Plan No. 4 of 1978, 43 FR 47713 (Oct. 17,
1978), 3 CFR, 1978 Comp. 332, effective Dec. 31, 1978, 44 FR 1065
(Jan. 3, 1978), 3 CFR, 1978 Comp. 332. 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, Pub. L. 107-16, 115 Stat. 38). Sec. 2550.408b-1 also
issued under 29 U.S.C. 1108(b)(1) and sec. 102, Reorganization Plan
No. 4 of 1978, 3 CFR, 1978 Comp. p. 332, effective Dec. 31, 1978, 44
FR 1065 (Jan. 3, 1978), and 3 CFR, 1978 Comp. 332. Sec. 2550.408b-19
also issued under sec. 611, Public Law 109-280, 120 Stat. 780, 972,
and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp.
p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3
CFR, 1978 Comp. 332. Sec. 2550.408g-1 also issued under sec. 102,
Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp. p. 332,
effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3 CFR, 1978
Comp. 332. Sec. 2550.408g-2 also issued under 29 U.S.C. 1108(g) and
sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp. p.
332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 1978), and 3 CFR,
1978 Comp. 332. Sec. 2550.412-1 also issued under 29 U.S.C. 1112.
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.
This section, at paragraph (d), prescribes, pursuant to section 408(a)
of ERISA and section 4975(c)(2) of the Code, a class exemption for
certain transactions not otherwise covered by the statutory exemption.
The requirements and conditions set forth in this section apply solely
for the relief described in paragraphs (b) and (d) 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.
(2) Nothing contained in ERISA section 408(g)(1), Code section
4975(f)(8), this regulation or the class exemption contained herein
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), this regulation or the class exemption contained herein
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
[[Page 3847]]
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 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) Any fees or other compensation (including salary, bonuses,
awards, promotions, commissions or other things of value) received,
directly or indirectly, by any employee, agent or registered
representative that provides investment advice on behalf of a fiduciary
adviser does not vary depending on the basis of any investment option
selected by a participant or beneficiary;
(E) Any fees (including any commission or other compensation)
received by the fiduciary adviser for investment advice or with respect
to the sale, holding, or acquisition of any security or other property
for purposes of investment of plan assets do not vary depending on the
basis of any investment option selected by a participant or
beneficiary; and
(ii) The requirements of paragraphs (b)(5), (6), (7), and (8) and
paragraph (e) 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), and
(8) and paragraph (e) are met.
(i) A computer model shall be designed and operated to--
(A) Apply generally accepted investment theories that take into
account the historic 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) 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;
(D) Utilize appropriate objective criteria to provide asset
allocation portfolios comprised of investment options available under
the plan;
(E) 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
(F)(1) Except as provided in clause (2) of this paragraph (F), 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 investment primarily in qualifying employer
securities;
(ii) Constitutes an investment fund, product or service 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 (such as retirement age or life expectancy) or
level of risk of the participant or beneficiary, 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 funds, products or services and how they
operate; or
(iii) 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.
(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,
[[Page 3848]]
obtain a new certification from an eligible investment expert that the
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.
(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), 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) 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), 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, setting 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--Statutory, U.S. Department of
Labor, Employee Benefits Security Administration, Room N-1513, 200
Constitution Ave., NW., Washington, DC 20210.
(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.
(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. (i) The fiduciary adviser must provide, without
charge, to a participant or a beneficiary before the initial provision
of 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
[[Page 3849]]
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, including, with respect to a computer model arrangement
referred to in paragraph (b)(4) of this section, any limitations on the
ability of a computer model to take into account an investment
primarily in qualifying employer securities;
(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) 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.
(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 any of clauses (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.
(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; or
(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.
(5) An ``affiliate'' of another person means--
(i) Any person directly or indirectly owning, controlling, or
holding with
[[Page 3850]]
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) Class exemption. (1) General. Pursuant to section 408(a) of the
Act and section 4975(c)(2) of the Code--
(i) The restrictions of sections 406(a) and 406(b) of the Act and
the sanctions resulting from the application of section 4975 of the
Code, by reason of section 4975(c)(1)(A) through (F) of the Code, shall
not apply to:
(A) The provision of investment advice described in section
3(21)(A)(ii) of the Act by a fiduciary adviser to a participant or
beneficiary of an individual account plan that permits such participant
or beneficiary to direct the investment of their individual accounts;
(B) The acquisition, holding, or sale of a security or other
property pursuant to the investment advice; and
(C) except as otherwise provided in this exemption, the direct or
indirect receipt of fees or other compensation by the fiduciary adviser
(or any employee, agent, registered representative or affiliate
thereof) in connection with the provision of the advice or in
connection with an acquisition, holding, or sale of a security or other
property pursuant to the investment advice, provided that the
conditions set forth in paragraph (d)(2) are met;
(ii) The sanctions resulting from the application of section 4975
of the Code, by reason of section 4975(c)(1)(A) through (F) of the
Code, shall not apply to:
(A) The provision of investment advice described in section
4975(e)(3)(B) of the Code by a fiduciary adviser to a beneficiary of an
IRA that permits such beneficiary to direct the investment of the
assets of his or her IRA;
(B) The acquisition, holding, or sale of a security or other
property pursuant to the investment advice; and
(C) Except as otherwise provided in this exemption, the direct or
indirect receipt of fees or other compensation by the fiduciary adviser
(or any employee, agent, registered representative or affiliate
thereof) in connection with the provision of the advice or in
connection with an acquisition, holding, or sale of a security or other
property pursuant to the investment advice, provided that the
conditions set forth in paragraph (d)(2) of this section are met.
(2) Conditions. The relief described in paragraph (d)(1) shall be
available if the fiduciary adviser--
(i) Provides investment advice in accordance with paragraphs (d)(3)
or (4), or both; and
(ii) Satisfies the requirements of paragraphs (d)(5) through (10).
(3) Use of computer model or investment education. The requirements
of this paragraph (d)(3) will be satisfied if:
(i) Except as provided in paragraph (d)(3)(ii), before providing
other investment advice covered by this exemption, the participant or
beneficiary shall be furnished with investment recommendations
generated by a computer model that--
(A) Meets the requirements of paragraphs (b)(4)(i) and (ii); or
(B) Meets the requirements of paragraph (b)(4)(i) and was designed
and is maintained by a person independent of the fiduciary adviser (and
any of the adviser's affiliates) and utilizes methodologies and
parameters determined appropriate solely by the independent person,
without influence from the fiduciary adviser (or any of the adviser's
affiliates); for purposes of this paragraph (d)(3)(i), a person is
``independent'' of another person if it is not an affiliate of the
other person, and does not have a material affiliation or material
contractual relationship with the other person.
(ii)(A) In the case of a plan that offers a ``brokerage window,''
``self-directed brokerage account'' or similar arrangement that enables
participants and beneficiaries to select investments beyond those
designated by the plan, if any, before providing investment advice with
respect to any investment utilizing such arrangement, the participant
or beneficiary shall be furnished the material described in paragraph
(d)(3)(ii)(B) and, if the plan offers designated investment options,
the participant or beneficiary also shall be furnished the
recommendations described in paragraph (d)(3)(i ) with regard to such
options.
(B) In the case of an IRA with respect to which the types or number
of investment choices reasonably precludes the use of a computer model
meeting the requirements of section 408(g)(3)(B) of ERISA to generate
recommendations, before providing other investment advice covered by
this exemption, the participant or beneficiary shall be furnished with
material, such as graphs, pie charts, case studies, worksheets, or
interactive software or similar programs, that reflect or produce asset
allocation models taking into account the age (or time horizon) and
risk profile of the beneficiary, to the extent known. Nothing shall
preclude the furnishing of material, in addition to the foregoing,
reflecting asset allocation portfolios of hypothetical individuals with
different time horizons and risk profiles. For purposes of any
materials provided pursuant to this paragraph (d)(3)(ii):
(1) Models must be based on generally accepted investment theories
that take into account the historic returns of different asset classes
(e.g., equities, bonds, or cash) over defined periods of time;
(2) Such models must operate in a manner that is not biased in
favor of investments offered by the fiduciary adviser or a person with
a material affiliation or material contractual relationship with the
fiduciary adviser; and
(3) All material facts and assumptions on which such models are
based (e.g., retirement ages, life expectancies, income levels,
financial resources, replacement income ratios, inflation
[[Page 3851]]
rates, and rates of return) accompany the models.
(iii) The fiduciary adviser shall retain the information furnished
pursuant to paragraph (d)(3)(i) or (ii) in accordance with paragraph
(e) of this section.
(4) Use of fee-leveling. Any fees or other compensation (including
salary, bonuses, awards, promotions, commissions or any other thing of
value) received, directly or indirectly, by an employee, agent or
registered representative providing advice on behalf of the fiduciary
adviser pursuant to this exemption (as distinguished from any
compensation received by the fiduciary adviser on whose behalf the
employee, agent or registered representative is providing such advice)
do not vary depending on the basis of any investment option selected by
a participant or beneficiary.
(5) Authorized by a plan fiduciary or IRA beneficiary. (i) Except
as provided in paragraph (d)(5)(ii), the arrangement pursuant to which
investment advice is provided to participants and beneficiaries is
expressly authorized in advance by a plan fiduciary (or, in the case of
an IRA, the IRA beneficiary) other than: The person offering the
investment advice 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
(d)(5)(i) 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
(d)(5)(i), 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) Basis for advice. (i) The investment advice--
(A) Is based on generally accepted investment theories that take
into account the historic returns of different asset classes over
defined periods of time; provided, however, that nothing herein shall
preclude any investment advice from being based on generally accepted
investment theories that take into account additional considerations;
(B) Takes into account investment management and other fees and
expenses attendant to the recommended investments; and
(C) 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 (d)(6)(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.
(ii) In connection with the provision of the investment advice--
(A) The fiduciary adviser concludes that the advice to be provided
is prudent and in the best interest of the participant or beneficiary,
and explains to the participant or beneficiary--
(1) The basis for the conclusion,
(2) If applicable, why the advice includes an option(s) with higher
fees than other options in the same asset class(es) available under the
plan, and
(3) If applicable, in the case of investment advice provided
pursuant to paragraph (d)(3)(i) or (ii), how the advice deviates from
or relates to the information provided pursuant to such paragraphs;
(B) Not later than 30 days following the explanation described in
paragraph (d)(6)(ii)(A), the employee, agent, or registered
representative providing the advice on behalf of the fiduciary adviser
shall document such explanation; and
(C) The fiduciary adviser retains the documentation developed
pursuant to paragraph (d)(6)(ii)(B) in accordance with paragraph (e) of
this section.
(7) Policies and procedures. The fiduciary adviser adopts and
follows written policies and procedures that are designed to assure
compliance with the conditions of this exemption.
(8) Disclosure. (i) The fiduciary adviser provides, without charge,
to the participant or beneficiary before the initial provision of
investment advice under the class exemption, 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 computer model described in paragraph (d)(3)(i) of
this section or, if applicable, the materials described in paragraph
(d)(3)(ii) of this section, and, to the extent applicable, in the
selection of investment options available under the plan;
(B) The types of services provided by the fiduciary adviser in
connection with the provision of investment advice by the fiduciary
adviser, including, with respect to a computer model arrangement
referred to in paragraph (d)(3)(i) of this section, any limitations on
the ability of a computer model to take into account an investment
primarily in qualifying employer securities; and
(C) The information described in paragraphs (b)(7)(i)(B) through
(E), (G) and (H);
(ii)(A) Such notification must be written in a clear and
conspicuous manner and in a manner calculated to be understood by the
average plan participant and shall be sufficiently accurate and
comprehensive to reasonably apprise such participants and beneficiaries
of the information required to be disclosed;
(B) The appendix to this section contains a model disclosure form
that may be used to provide the notification of information described
in paragraph (b)(7)(i)(C). Use of the model disclosure form is not
mandatory. However, use of an appropriately completed model disclosure
form will be deemed to satisfy the requirements of paragraphs
(d)(8)(i)(C) and (d)(8)(ii)(A) with respect to such information.
(iii) Such notification 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 (d)(8)(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 (d)(8)(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 (d)(8)(i) at
a time reasonably
[[Page 3852]]
contemporaneous to the change in information.
(9) 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 for compliance with the policies and
procedures of paragraph (d)(7) of this section and the requirements of
paragraph (d) of this section; and
(B) Within 60 days following the 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
arrangement, in accordance with paragraph (d)(5), setting forth the
specific findings of the auditor regarding compliance of the
arrangement with the policies and procedures of paragraph (d)(7) and
the requirements of paragraph (d) 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, 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 (d)(8) 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 policies and procedures required by paragraph
(d)(7) or the conditions of paragraph (d) of this section, within 30
days following receipt of the report from the auditor, sends a copy of
the report to the Department of Labor at the following address:
Investment Advice Notification--Class Exemption, U.S. Department of
Labor, Employee Benefits Security Administration, Room N-1513, 200
Constitution Ave., NW., Washington, DC 20210.
(iii) For purposes of paragraph (d)(9)(i), 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 IRA or any designated investment options
under the plan or IRA.
(iv) For purposes of the audit described in paragraph (d)(9)(i),
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 policies and
procedures of paragraph (d)(7) of this section and the requirements of
this paragraph (d); provided, however, that nothing in this
subparagraph 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
(d)(9) is a fiduciary act governed by section 404(a)(1) of ERISA.
(10) Other. The requirements of paragraph (b)(8), relating to other
conditions, and paragraph (e), relating to retention of records, of
this section are met.
(e) 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.
(f) 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 paragraphs (b) and
(d) 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) or (d) 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.
(g) Applicability date. This section shall apply to transactions
described in paragraphs (b) and (d) of this section occurring on or
after March 23, 2009.
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
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
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]
[[Page 3853]]
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 not material affiliation with or receive
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 subparagraph
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 fiduciary 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(e).
Signed at Washington, DC, this 9th day of January, 2009.
Bradford P. Campbell,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. E9-710 Filed 1-16-09; 8:45 am]
BILLING CODE 4510-29-P