[Federal Register: August 22, 2008 (Volume 73, Number 164)]
[Proposed Rules]
[Page 49895-49923]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22au08-24]
[[Page 49895]]
-----------------------------------------------------------------------
Part V
Department of Labor
-----------------------------------------------------------------------
Employee Benefits Security Administration
-----------------------------------------------------------------------
29 CFR Parts 2550
Investment Advice--Participants and Beneficiaries; Proposed Class
Exemption for the Provision of Investment Advice to Participants and
Beneficiaries of Self-Directed Individual Account Plans and IRAs;
Proposed Rule; Notice
[[Page 49896]]
-----------------------------------------------------------------------
DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB13
Investment Advice--Participants and Beneficiaries
AGENCY: Employee Benefits Security Administration, DOL.
ACTION: Proposed rule.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations implementing the
provisions of the statutory exemption set forth in sections 408(b)(14)
and 408(g) of the Employee Retirement Income Security Act, as amended
(ERISA or the Act), and parallel provisions in the Internal Revenue
Code of 1986, as amended (Code), relating to the provision of
investment advice described in the Act 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). Section 408(b)(14)
provides an exemption from certain prohibited transaction provisions in
ERISA with respect to the provision of investment advice, the
investment transaction entered into 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
advice or the transaction pursuant to the advice. Section 408(g)
describes the conditions under which the investment advice-related
transactions are exempt. Upon adoption, the regulations will 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: Written comments on the proposed regulations should be submitted
to the Department of Labor on or before October 6, 2008.
ADDRESSES: To facilitate the receipt and processing of comment letters,
the Employee Benefits Security Administration (EBSA) encourages
interested persons to submit their comments electronically by e-mail to
e-ORI@dol.gov (Subject: Investment Advice Regulations), or by using the
Federal eRulemaking portal at http://www.regulations.gov (follow
instructions for submission of comments). Persons submitting comments
electronically are encouraged not to submit paper copies. Persons
interested in submitting paper copies should send or deliver their
comments to the Office of Regulations and Interpretations, Employee
Benefits Security Administration, Attn: Investment Advice Regulations,
Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW.,
Washington, DC 20210. All comments will be available to the public,
without charge, online at http://www.regulations.gov and http://
www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, Employee
Benefits Security Administration, U.S. Department of Labor, 200
Constitution Avenue, NW., Washington, DC 20210.
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 ERISA includes 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.
---------------------------------------------------------------------------
\1\ See also Code section 4975(e)(3)(B); 29 CFR 2510.3-21(c).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\2\ See Interpretative Bulletin relating to participant
investment education, 29 CFR Sec. 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).
---------------------------------------------------------------------------
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 section 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.
---------------------------------------------------------------------------
\4\ Under Reorganization Plan No. 4 of 1978 (43 FR 47713,
October 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.
---------------------------------------------------------------------------
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
[[Page 49897]]
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 have been taken into account in developing the proposed
regulations.
---------------------------------------------------------------------------
\5\ 71 FR 70429, Dec. 4, 2006. The Department, on the same date,
also published a Request for Information in the Federal Register
soliciting information to assist the Department in determining the
feasibility of using computer models in connection with individual
retirement accounts, as required by PPA section 601(b)(3). 72 FR
70427, Dec. 4, 2006.
---------------------------------------------------------------------------
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 (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 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). The
Department's views on that issue are set forth in the discussion of the
proposed regulations that follows.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
The proposed regulations contained in this notice 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). In this regard, the Department notes
that, in an effort to ensure broad availability of investment advice to
both participants and beneficiaries in individual account plans and
beneficiaries with individual retirement accounts, the Department also
is publishing a proposed class exemption for the provision of
investment advice to such individuals. The proposed class exemption
appears in the Notice section of today's Federal Register.
B. Overview of Proposed Sec. 2550.408g-1
1. General
In general, proposed Sec. 2550.408g-1 tracks the requirements
under section 408(g) that must be satisfied in order for the investment
advice-related transactions described in section 408(b)(14) to be
exempt from the prohibitions of section 406.
Paragraph (a) of the proposal sets forth the general scope of the
statutory exemption and regulation as providing relief from the
prohibitions of section 406 of ERISA for transactions described in
section 408(b)(14) of ERISA in connection with the provision of
investment advice to a participant or a beneficiary if the investment
advice is provided by a fiduciary adviser under an ``eligible
investment advice arrangement.'' Paragraph (a) also notes that the Code
contains parallel provisions at section 4975(d)(17) and (f)(8).
Paragraph (b) of the proposal provides that, for purposes of
sections 408(g)(1) of ERISA and section 4975(f)(8) of the Code, an
``eligible investment advice arrangement'' shall mean an arrangement
that meets either the requirements of paragraph (c) [describing
investment advice arrangements that use fee-leveling] or paragraph (d)
[describing investment advice arrangements that use computer modeling]
of the proposal or both.
2. Fee-Leveling
With respect to arrangements that use fee-leveling, paragraph (c)
of the proposal requires that any investment advice be based on
generally accepted investment theories that take into account the
historic returns of different asset classes over defined periods of
time, although nothing in the proposal is intended to preclude
investment advice from being based on generally accepted investment
theories that take into account additional considerations. Paragraph
(c) also requires that any investment advice take into account
information furnished by a participant or beneficiary relating to age,
life expectancy, retirement age, risk tolerance, other assets or
sources of income, and investment preferences, although nothing in the
proposal is intended to preclude a fiduciary adviser from taking into
account additional information that a participant or beneficiary may
provide. While section 408(g)(2)(A)(i) does not specifically reference
such conditions, the principles are so fundamental to the provision of
informed, individualized investment advice that a failure on the part
of a plan fiduciary to insist on such conditions in the selection of an
investment adviser for plan participants would, in the Department's
view, raise serious questions as to the fiduciary's exercise of
prudence. For this reason, the Department determined that such
conditions are sufficiently significant that they should be included in
the regulation implementing the statutory exemption for investment
advice.
With regard to compensation and fees for the provision of
investment advice, paragraph (c)(1)(iii) 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 does not vary
depending on the basis of any investment option selected by a
participant or beneficiary. Paragraph (c)(1)(iv) 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 do not vary depending on the basis of any
investment option selected by a participant or beneficiary.
The individual compensation requirement in paragraph (c)(1)(iii) is
designed to safeguard against a firm's creation of incentives for
individuals to recommend certain investment products. It appears that,
while an individual may have a general interest in the overall success
of his or her employing firm, this interest, by itself, would not be
inconsistent with the individual compensation requirement. This would
not be the case, however, if the individual's direct or indirect
compensation or benefits vary based on the selection of particular
investment options. In order to determine whether more precise guidance
can be developed, we request public comment on the types and
formulations of direct and indirect compensation arrangements being
utilized, and how they may operate under this provision.
[[Page 49898]]
With regard to the foregoing, the Department, in interpreting the
scope of the fee-leveling requirement for purposes of section
408(g)(2)(A)(i), expressed its view, in Field Assistance Bulletin 2007-
01 (February 2, 2007), that only the fees or other compensation of the
fiduciary adviser may not vary. In contrast to other provisions of
section 408(b)(14) and section 408(g), the Department explained,
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 noted that, consistent with past
guidance, if the fees and compensation received by an affiliate of a
fiduciary that provides investment advice do not vary or are offset
against those received by the fiduciary for the provision of investment
advice, no prohibited transaction would result solely by reason of
providing investment advice and thus there would be no need for a
prohibited transaction exemption.\7\ The Department, therefore,
concluded that Congress did not intend 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
continues to be the view of the Department.
---------------------------------------------------------------------------
\7\ See AO 2005-10A; AO 97-15A.
---------------------------------------------------------------------------
The Department also noted in the Bulletin that, although section
408(g)(11)(A) generally limits ``fiduciary advisers'' to certain types
of entities, it also permits employees, agents, or registered
representatives of those entities to also qualify as fiduciary advisers
if they satisfy the requirements of applicable insurance, banking, and
securities laws relating to the provision of the advice. See section
408(g)(11)(A)(vi). As with affiliates, such an individual must, for
purposes of section 408(g)(11)(A), not only be an employee, agent, or
registered representative of one of those entities, but also must
provide investment advice in his or her capacity as employee, agent, or
registered representative. The Department, therefore, concluded that
the language of section 408(g)(11)(A) required a finding that, for
purposes of the statutory exemption, when an individual acts as an
employee, agent or registered representative on behalf of an entity
engaged to provide investment advice to a plan, that individual, as
well as the entity, must be treated as the fiduciary adviser for
purposes of section 408(g)(11)(A) and, accordingly subject to the
limitations of section 408(g)(2)(A)(i). In an effort to accommodate a
wider variety of business structures and practices, making investment
advice more available while protecting participants and beneficiaries,
the Department is proposing a class exemption addressing fee leveling
requirements for employees, agents and registered representatives, also
appearing in today's Federal Register.
In addition to the foregoing, fiduciary advisers utilizing
investment advice arrangements that employ fee-leveling must comply
with the requirements of paragraphs (e) [authorization by plan
fiduciary], (f) [audits], (g) [disclosure], (h) [miscellaneous], and
(i) [maintenance of records] of the proposal, each of which is
discussed in more detail below.
3. Computer Models
Paragraph (d) of the proposal addresses the requirements applicable
to investment advice arrangements that rely on computer models. In this
regard, paragraph (d) provides, consistent with the provisions of
section 408(g)(3)(B), (C) and (D), that an arrangement shall be 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 (d)(1) and (2) of this section
under an investment advice program, and with respect to which the
requirements of paragraphs (e) [authorization by plan fiduciary], (f)
[audits], (g) [disclosure], (h) [miscellaneous], and (i) [maintenance
of records] of the proposal are met and any acquisition, holding or
sale of a security or other property pursuant to such advice occurs
solely at the direction of the participant or beneficiary.
Paragraph (d)(1), consistent with section 408(g)(3)(B)(i)-(v), sets
forth the standards applicable to computer models. Specifically,
paragraph (d)(1) requires that a computer model be designed and
operated to: apply generally accepted investment theories that take
into account the historic returns of different asset classes over
defined periods of time, although nothing in the proposal is intended
to preclude a computer model from applying generally accepted
investment theories that take into account additional considerations;
utilize information furnished by a participant or beneficiary relating
to age, life expectancy, retirement age, risk tolerance, other assets
or sources of income, and investment preferences, although nothing in
the proposal precludes a computer model from taking into account
additional information that a plan or a participant or beneficiary may
provide; and utilize appropriate objective criteria to provide asset
allocation portfolios comprised of investment options available under
the plan. See paragraph (d)(1)(i)-(iii) of the proposal.
In addition to the foregoing, a computer model, consistent with
section 408(g)(3)(B)(iv),\8\ must be designed and operated to avoid
investment recommendations that: 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 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. In order to determine if further guidance can be developed
with respect to this provision, the Department seeks public comment on
circumstances under which it would be appropriate or inappropriate to
favor particular investment options. For example, the Department
believes that favoring a higher-cost investment alternative over an
otherwise identical investment alternative with lower cost would be
inappropriate.
---------------------------------------------------------------------------
\8\ Pursuant to section 408(g)(3)(B)(iv), a computer model 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 contractual relationship with the fiduciary
adviser.''
---------------------------------------------------------------------------
As reflected in the language, a computer model would not fail to
meet this requirement 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 models 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 proposal
defines
[[Page 49899]]
a ``material affiliation'' and ``material contractual relationship'' at
paragraphs (j)(6) and (j)(7), respectively.
Paragraph (d)(1) further requires, consistent with section
408(g)(3)(B)(v),\9\ that computer models take into account all
``designated investment options'' available under the plan without
giving inappropriate weight to any investment option. See paragraph
(d)(1)(v) of the proposal. The term ``designated investment option'' is
defined in paragraph (j)(1) of the proposal, 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.
---------------------------------------------------------------------------
\9\ Section 408(g)(3)(B)(v) provides that computer models must
take ``into account all investment options under the plan in
specifying how a participant's account balance should be invested
and is not inappropriately weighted with respect to any investment
option.''
---------------------------------------------------------------------------
Paragraph (d)(1)(v) also 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. Any such limitation on the investment advice to be
generated by the computer model, however, must be disclosed to
participants and beneficiaries under paragraph (g)(1)(vi) of the
proposal, discussed below. Information received by the Department in
response to both of its RFIs indicated that there are challenges
attendant to developing computer models, which generally are based on
underlying theories that rely on diversified asset classes, that
address a single undiversified security, such as qualifying employer
securities, in connection with generating investment recommendations
that would enable a participant to construct a well-diversified
investment portfolio. The Department is concerned that extending this
requirement to qualifying employer securities might discourage
arrangements based on utilization of a computer model, or otherwise
limit their availability.\10\ Accordingly, the Department has excluded
investments primarily in qualifying employer securities from the
requirement of paragraph (d)(1)(v) of the proposal.
---------------------------------------------------------------------------
\10\ It should be noted that, even in the absence of
individualized advice, participants are reminded on a quarterly
basis, via their pension benefit statements, of the importance of
maintaining a diversified portfolio. Model language for purposes of
this disclosure was set forth in Field Assistance Bulletin 2006-03
(Dec. 20, 2006). Among other things the model language provides that
``[I]f you invest more than 20% of your retirement savings in any
one company or industry, your savings may not be properly
diversified. Although diversification is not a guarantee against
loss, it is an effective strategy to help you manage investment
risk.''
---------------------------------------------------------------------------
Paragraph (d)(2) of the proposal requires that, prior to
utilization of the computer model, the fiduciary adviser obtain a
written certification that the computer model meets the requirements of
paragraph (d)(1), discussed above. If the model is modified in a manner
that may affect its ability to meet the requirements of paragraph
(d)(1), the fiduciary adviser, prior to utilization of the modified
model, must obtain a new certification. With regard to the
certification, paragraph (d)(2) requires that the fiduciary adviser
obtain a certification that meets the requirements of paragraph (d)(4)
from an ``eligible investment expert,'' within the meaning of paragraph
(d)(3).
Paragraph (d)(3) of 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
(d)(4), whether a computer model meets the requirements of paragraph
(d)(1) 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. After consideration of the public
comments, the Department has concluded that it would be 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.
Accordingly, under the proposal, it is the fiduciary adviser who is
responsible for determining whether an eligible investment expert,
itself or its employees, possesses the requisite training and
experience to certify whether a given computer model meets the
requirements of paragraph (d)(1) in a manner consistent with paragraph
(d)(4) of the proposal. Paragraph (d)(5) of the proposal provides that,
for purposes of the statutory exemption, the selection of the eligible
investment expert by the fiduciary adviser is a fiduciary act governed
by section 404(a)(1) of ERISA.
The Department notes that, although the proposal 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 exemption are
satisfied with respect to its arrangement. We also note that section
404 of ERISA requires the fiduciary adviser to act reasonably and
prudently in its selection.
Paragraph (d)(4) of the proposal 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 (d)(1) of this section; an explanation of how
the applied methodology or methodologies demonstrated that the computer
model met the requirements of paragraph (d)(1) of this section; 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 (d)(1). 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 (d)(1); and a statement
certifying that the eligible investment expert has determined that the
computer model meets the requirements of paragraph (d)(1). Finally the
certification must be signed by the eligible investment expert.
With regard to the certification described in paragraph (d)(4) of
the proposal, public comments suggested a number of different
approaches that could be followed in determining computer model
consistency with the statutory criteria. The comments did not, however,
suggest a single suitable approach. The Department, therefore, is wary
of mandating a methodology under the proposal. The Department also
believes that as computer models and their use under investment advice
arrangements continue to develop, experts may need the flexibility to
develop new methodologies for examining those models. Accordingly,
paragraph (d)(4) does not require a particular methodology to be
applied for purposes of certification.
[[Page 49900]]
4. Authorized by a Plan Fiduciary
Consistent with the section 408(g)(4) of ERISA, the proposal
provides, at paragraph (e), 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 proposal 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.
5. Annual Audit
Paragraph (f) addresses the audit requirements of section 408(g)(6)
of ERISA. Specifically, paragraph (f)(1) 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 proposal and 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, consistent
with paragraph (e) of the proposal, setting forth the specific findings
of the auditor regarding compliance of the arrangement with the
requirements of the proposal.
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 for IRAs. This alternative is set
forth in paragraph (f)(2) of the proposal. The alternative provides
that, with respect to an arrangements 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 website, provided that such beneficiaries
are provided information, along with other required disclosures (see
paragraph (g) of the proposal), 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 website, 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) \11\
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 solicits comments on this finding. Paragraph
(f)(2) also provides 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. As proposed,
the fiduciary adviser must submit the report to the Department within
30 days following receipt of the report from the auditor. The
submission of this report will enable the Department to monitor
compliance with the statutory exemption in those instances where there
is no authorizing ERISA plan fiduciary to carry out that function.
---------------------------------------------------------------------------
\11\ 15 U.S.C. 7004(d)(1) (2000).
---------------------------------------------------------------------------
For purposes of paragraph (f) of the proposal, 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. The terms ``material affiliation'' and
``material contractual relationship'' are defined in paragraphs (j)(6)
and (7) of the proposal.
With regard to the scope of the audit, paragraph (f)(4) 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 (f)(4) 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 proposal,
therefore, 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 proposal leaves
to the auditor the determination as to the appropriate scope of their
review and the extent to which they can rely on representative samples
for determining compliance with the exemption.
6. Disclosure
The disclosure provisions are set forth in paragraph (g) of the
proposal and generally track the disclosure provisions of the statutory
exemption at section 408(g)(6) of ERISA. In this regard, the proposal,
at paragraph (g)(1), 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 the
investment advice program, and in the selection of investment options
available under the plan; the past performance and historical rates of
return of the designated investment options available under the plan,
to the extent that such information is not otherwise provided; all fees
or other compensation relating to the advice that the fiduciary adviser
or any affiliate thereof is to receive (including compensation provided
by any third party) in connection with the provision of the advice or
in connection with the sale, acquisition, or holding of the security or
other property; 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 described in
paragraph (d) utilizing a computer model, any limitations on the
ability of the model to take into account an investment primarily in
qualifying employer securities, as provided for in paragraph (d)(1)(v)
of the proposal; 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.
[[Page 49901]]
Paragraph (g)(2) of the proposal requires that the notification
furnished to participants and beneficiaries 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.
The appendix to the proposal contains a model disclosure form that
may be used for purposes of satisfying the fee and compensation
disclosure requirement of paragraph (g)(1)(iii), as well as the
requirements of paragraph (g)(2), of the proposal. The proposal makes
clear, however, that the use of the model disclosure form is not
mandatory.
Paragraph (g)(3) makes clear that the required disclosures may be
provided in written or electronic form.
Paragraph (g)(4) of the proposal, like section 408(g)(6)(B) of
ERISA, sets forth miscellaneous recordkeeping and furnishing
responsibilities of the fiduciary adviser. Specifically, paragraph
(g)(4) provides 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 described in
paragraph (g)(1) in accurate form; provide, without charge, accurate
information 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, accurate information to the recipient of the advice
concerning any material change to the information required to be
provided to the recipient of the advice at a time reasonably
contemporaneous to the change in information.
7. Other Conditions
Paragraph (h) of the proposal, like section 408(g)(7) of ERISA,
sets forth additional conditions applicable to the provision of advice
under the statutory exemption. These requirements are as follows: The
fiduciary adviser must provide appropriate disclosure, in connection
with the sale, acquisition, or holding of the security or other
property, in accordance with all applicable securities laws; the sale,
acquisition, or holding 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.
8. Maintenance of Records
Paragraph (i) of the proposal sets forth the record maintenance
requirements. Consistent with section 408(g)(9) of ERISA, paragraph (i)
of the proposal provides that the fiduciary adviser must maintain, for
a period of not less than 6 years after the provision of investment
advice pursuant to the arrangement, any records necessary for
determining whether the applicable requirements of the proposal have
been met. Also, paragraph (i), as with section 408(g)(9), makes clear
that a prohibited transaction 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.
9. Definitions
Paragraph (j) of the proposal sets forth a number of definitions
relevant to the statutory exemption and this proposed regulation.
Paragraph (j)(1), as discussed earlier, defines the term
``designated investment option.'' Paragraph (j)(2) sets forth the
definition of ``fiduciary adviser,'' as it appears in section
408(g)(11)(A) of ERISA. With regard to that part of the fiduciary
adviser definition that treats persons who develop computer models or
market investment advice programs or computer models as a fiduciary of
the plan by reason of providing investment advice and as a fiduciary
adviser for purposes of section 408(b)(14), the Department is proposing
a separate regulation (Sec. 2550.408g-2), discussed below, pursuant to
which a single fiduciary adviser may elect to be treated as a fiduciary
with the respect to the plan.
Paragraph (j)(3) of the proposal adopts the statutory definition of
``registered representative'' set forth in ERISA section 408(g)(11)(C),
which states that a registered representative of another entity means a
person described in section 3(a)(18) of the Securities Exchange Act of
1934 (15 U.S.C. 78c(a)(18)) (substituting the entity for the broker or
dealer referred to in such section) or a person described in section
202(a)(17) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-
2(a)(17)) (substituting the entity for the investment adviser referred
to in such section).
Paragraph (j)(4), consistent with section 601(b)(3)(A)(i) of the
Pension Protection Act of 2006, defines the term ``Individual
Retirement Account'' to mean plans described in paragraphs (B) through
(F) of section 4975(e)(1) of the Code, as well as a trust, plan,
account, or annuity which, at any time, has been determined by the
Secretary of the Treasury to be described in such paragraphs.
Paragraph (j)(5) of the proposed rule defines the term
``affiliate.'' For purposes of the proposal, an ``affiliate'' of
another person means: Any person directly or indirectly owning,
controlling, or holding with power to vote, 5 percent or more of the
outstanding voting securities of such other person; 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; any person directly or indirectly controlling, controlled by,
or under common control with, such other person; and any officer,
director, partner, copartner, or employee of such other person.
Consistent with ERISA section 408(g)(11)(B), this definition is based
on the definition of an ``affiliated person'' of an entity as contained
in section 2(a)(3) of the Investment Company Act of 1940 (ICA), except
that it does not reflect clauses (E) and (F) thereof. The Department
has initially determined that including provisions similar to clauses
(E) and (F) is unnecessary, because these clauses appear to focus on
persons who exercise control over the management of an investment
company.\12\ Also, such parties will nonetheless be treated as an
affiliate because they would be a person directly or indirectly
controlling, controlled by, or under common control with, such other
person. See paragraph (j)(5)(iii) of the proposal. Additionally, the
Department is concerned that including provisions similar to clauses
(E) and (F), which focus on functions involving investment companies,
but not other types of vehicles in which plans may invest, could have
the unintended consequence of possibly subjecting persons associated
with investment companies to different requirements under these
proposed regulations. Therefore, the Department is proposing to define
affiliate without regard to clauses (E) and (F) of section 2(a)(3) of
the ICA.
---------------------------------------------------------------------------
\12\ ICA section 2(a)(3)(E) and (F) include in the definition of
affiliated person: If the other person is an investment company, any
investment adviser thereof or any member of an advisory board
thereof; and if such other person is an unincorporated investment
company not having a board of directors, the depositor thereof. 15
U.S.C. 80a-2(a)(3)(E)-(F).
---------------------------------------------------------------------------
In a variety of places in the regulation reference is made to
persons with
[[Page 49902]]
``material affiliations'' and ``material contractual relationships.''
See paragraphs (d)(1)(iv), (d)(3), (f)(3), (g)(1)(i), (g)(1)(iv) and
(g)(1)(viii) of the proposal. For purposes of this regulation, those
terms are defined in paragraphs (j)(6) and (j)(7), respectively.
Paragraph (j)(6) of the proposal describes a person with a
``material affiliation'' with another person as: Any affiliate of such
other person; any person directly or indirectly owning, controlling, or
holding, 5 percent or more of the interests of such other person; or
any person 5 percent or more of whose interests are directly or
indirectly owned, controlled, or held, by such other person. In
determining ``interest,'' paragraph (j)(6)(ii) provides that an
``interest'' means with respect to an entity: The combined voting power
of all classes of stock entitled to vote or the total value of the
shares of all classes of stock of the entity if the entity is a
corporation; the capital interest or the profits interest of the entity
if the entity is a partnership; or the beneficial interest of the
entity if the entity is a trust or unincorporated enterprise.
Paragraph (j)(7) of the proposal provides that persons shall be
treated as having a ``material contractual relationship'' if payments
made by one person to the other person pursuant to written contracts or
agreements between the persons exceed 10 percent of the gross revenue,
on an annual basis, of such other person. The Department believes that
one person's receipt of more than 10 percent of gross revenue from
another person is sufficiently significant to be considered material.
However, the Department specifically invites comments on whether the
percentage test should be higher or lower and, if so, why.
The proposal, at paragraph (j)(8), defines ``control'' to mean the
power to exercise a controlling influence over the management or
policies of a person other than an individual.
C. Overview of Proposed Sec. 2550.408g-2
Proposed Sec. 2550.408g-2, as indicated above, addresses 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. See section 408(g)(11)(A).
Section 408(g)(11)(A) provides that, with respect to an arrangement
that relies on use of a computer model to qualify as an ``eligible
investment advice arrangement,'' 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 section 408(b)(14) and (g). Section
4975(f)(8) of the Code contains a parallel provision to ERISA section
408(g)(11)(A). Proposed Sec. 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(i).
D. Effective Date
The Department proposes that the regulations contained in this
notice will be effective 60 days after publication of the final
regulations in the Federal Register. The Department invites comments on
whether the final regulations should be made effective on a different
date.
E. Request for Comments
The Department invites comments from interested persons on the
proposed regulations. To facilitate the receipt and processing of
comment letters, the Employee Benefits Security Administration (EBSA)
encourages interested persons to submit their comments electronically
by e-mail to e-ORI@dol.gov (Subject: Investment Advice Regulations), or
by using the Federal eRulemaking portal at http://www.regulations.gov
(follow instructions for submission of comments). Persons submitting
comments electronically are encouraged not to submit paper copies.
Persons interested in submitting paper copies should send or deliver
their comments to the Office of Regulations and Interpretations,
Employee Benefits Security Administration, Attn: Investment Advice
Regulations, Room N-5655, U.S. Department of Labor, 200 Constitution
Avenue, NW., Washington, DC 20210. All comments will be available to
the public, without charge, online at http://www.regulations.gov and
http://www.dol.gov/ebsa and at the Public Disclosure Room, N-1513,
Employee Benefits Security Administration, U.S. Department of Labor,
200 Constitution Avenue, NW., Washington, DC 20210.
The comment period for the proposed regulations will end 45 days
after publication of the proposed rule in the Federal Register. The
Department believes that this period of time will afford interested
persons an adequate amount of time to analyze the proposals and submit
comments. Written comments on the proposed regulations should be
submitted to the Department of Labor on or before October 6, 2008.
F. Regulatory Impact Analysis
Summary
The Department anticipates that this proposed regulation and
proposed class exemption, by extending quality, expert investment
advice to more retirement plan participants, together will improve
their investment results by approximately $14 billion or more annually,
at a cost of $4 billion, thereby producing a net financial benefit of
$10 billion or more. The improved investment results will reflect
reductions in investment errors such as payment of higher than
necessary fees and expenses, poor trading strategies, and inadequate
diversification. The provisions of this proposed regulation and the
conditions attached to this proposed class exemption reflect the
Department's efforts to ensure that the advice provided pursuant to
them will be affordable and of high quality.
Introduction
Workers' retirement security increasingly depends on their
investment decisions. Unfortunately
[[Page 49903]]
there is evidence that many participants and beneficiaries in
participant-directed defined contribution (DC) plans and beneficiaries
of individual retirement accounts (IRAs) (collectively hereafter,
``participants''), beset by flawed information or reasoning, make poor
investment decisions. These participants may pay higher fees and
expenses than necessary for investment products and services, engage in
excessive or poorly timed trading or fail to rebalance their
portfolios, inadequately diversify their portfolios and thereby assume
uncompensated risk, take more or less than optimal levels of
compensated risk, and/or pay unnecessarily high taxes. Financial losses
(including foregone earnings) from such mistakes likely amount to more
than $100 billion per year. These losses compound and grow larger as
workers progress toward and into retirement.
Such mistakes and consequent losses historically can be attributed
at least in part to provisions of federal law that effectively preclude
a variety of arrangements whereby financial professionals might
otherwise provide retirement plan participants with expert investment
advice. These ``prohibited transaction'' provisions of ERISA and the
Internal Revenue Code prohibit fiduciaries from dealing with DC plan or
IRA assets in ways that advance their own interests. These provisions
prohibit plan fiduciaries from exercising the authority, control, or
responsibility that makes such persons fiduciaries when they have an
interest which may conflict with the interests of the plan for which
they act. Under these provisions financial advisers who have a direct
or indirect stake in participants' investment decisions generally may
not provide them with investment advice. In recognition that certain
transactions could nonetheless be beneficial to plans and their
participants and beneficiaries, subject to safeguards appropriate to
protect against potential abuses, Congress enacted a number of
statutory prohibited transaction exemptions, and also gave the
Department conditional authority to grant prohibited transaction
exemptions. In this regard, the prohibited transaction exemption for
the provision of investment advice added by the Pension Protection Act
of 2006 (PPA) opened the door to more types of investment advice
arrangements by conditionally permitting arrangements where the
fiduciary adviser or an affiliate thereof has a financial stake in the
advised participants' investment decisions. The Department is proposing
a regulation to further specify the PPA's applicable conditions,
together with a class exemption to establish alternative conditions
under which such arrangements may operate. Together these actions are
intended to increase the availability of investment advice.
The results of this proposed regulation and proposed class
exemption will depend on their impacts on the availability, cost, use,
and quality of participant investment advice. The Department expects
that, as a result of these actions, quality, affordable advice will
proliferate, producing significant net gains for participants.
Investment Mistakes
The Department believes that many participants make costly
investment mistakes and therefore could benefit from receiving and
following good advice. In theory, investors can optimize their
investment mix over time to match their investment horizon and personal
taste for risk and return. But in practice many investors do not
optimize their investments, at least not in accordance with generally
accepted financial theories.
Some investors fail to exhibit clear, fixed and rational
preferences for risk and return. Some base their decisions on flawed
information or reasoning. For example some appear to anchor decisions
inappropriately to plan features or to mental accounts or frames, or to
rely excessively on past performance measures or peer examples. Some
suffer from overconfidence, myopia, or simple inertia.\13\
---------------------------------------------------------------------------
\13\ See, e.g., Richard H. Thaler & Shlomo Benartzi, The
Behavioral Economics of Retirement Savings Behavior, AARP Public
Policy Institute White Paper 2007-02 (Jan. 2007); and Jeffrey R.
Brown & Scott Weisbenner, Individual Account Investment Options and
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social
Science Research Network Abstract 631886 (Dec. 2004).
---------------------------------------------------------------------------
Such informational and behavioral problems translate into at least
five distinct types of investment mistakes,\14\ which together generate
financial losses (including foregone earnings) of $109 billion or more
annually \15\ for DC plan and IRA participants, the Department
estimates.
---------------------------------------------------------------------------
\14\ It should be noted that much of the research documenting
investment mistakes does not account for whether advice was present
or not. At least some of the mistakes may have been made despite
good advice to the contrary; some may have been made pursuant to bad
advice. There is evidence both that advice sometimes is not
followed, and that it sometimes is bad. This is explored more below.
\15\ As discussed below, this estimate is subject to wide
uncertainty.
---------------------------------------------------------------------------
Fees and Expenses
Investors sometimes pay higher fees and expenses than necessary for
investment products and services. There is evidence that mutual funds
with poorer gross performance (that is performance before deducting
fees) also have higher fees. This suggests that higher fees sometimes
do not reflect value added by managers. Investors often pay inadequate
attention to fee differences, even in connection with highly comparable
products like competing S&P 500 index funds.\16\
---------------------------------------------------------------------------
\16\ A number of studies conclude that investors often pay
higher fees than necessary.
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) find
that funds with worse before-fee performance charge higher fees.
They suggest that funds faced with insensitive investors charge
higher fees, finding that even after controlling for performance
sensitivity, funds with lower expected performance set higher fees.
They hypothesize 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.
According to Ali Hortacsu & Chad Syverson, Product
Differentiation, Search Costs, and Competition in the Mutual Fund
Industry: A Case Study of S&P 500 Index Funds, Social Science
Research Network Abstract 405642 (April 2003), 75 percent of S&P 500
Index Funds have expense ratios in excess of 47 basis points, 50
percent in excess of 72 basis points and 25 percent in excess of 149
basis points. The highest cost fund charged annualized investor fees
that were nearly 30 times greater than the lowest-cost fund (268 vs.
9.5 basis points). Low-cost funds have a dominant market share, but
the asset share of the low-cost funds has fallen consistently since
1995.
Paul G. Mahoney, Manager-Investor Conflicts in Mutual Funds, The
Journal of Economic Perspectives, Volume 18, Number 2 (2004) extends
the Ali Hortacsu & Chad Syverson, Product Differentiation, Search
Costs, and Competition in the Mutual Fund Industry: A Case Study of
S&P 500 Index Funds, Social Science Research Network Abstract 405642
(April 2003) result of two classes of investors, the experienced
that buy low-cost no-load funds, and the novice who uses a broker
and buys high-cost load funds. He finds that, even after separating
the expense ratio into administrative fees and 12b-1 fees, funds
with loads still have administrative fees 15 basis point higher than
the no-load funds.
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, 2095-2119 (2005) find that investors are sensitive to
load fees. They argue that front-end load fees are generally
observable as a dollar amount on the first statement while the
effects of administrative fees on the account balance are hidden by
the volatility of fund returns. They find evidence of learning;
repeat mutual fund purchasers pay on average about half the load
fees of first time mutual fund purchasers.
Todd Houge & Jay W. Wellman, The Use and Abuse of Mutual Fund
Expenses, Social Science Research Network Abstract 880463 (Jan.
2006) present evidence that less knowledgable investors pay
consistently higher asset management fees than more knowledgable
investors holding similar funds. Less sophisticated investors are
more likely to invest in funds with loads. Load funds on average
have annual expense ratios that are 50 basis points higher than no-
load funds. While a large part of the higher expense ratio is
composed of 12b-1 fees, load funds also have higher asset management
fees. They conclude that ``Load fund shareholders often pay high
fees to market and grow the fund, but the fund's advisor is the most
likely beneficiary of this growth.''
Edwin J. Elton et al., Are Investors Rational? Choices Among
Index Funds, Social Science Research Network Abstract 340482 (June
2002) find that buying S&P 500 index mutual funds using expenses as
the predictor of future success leads to picking funds with better
returns. They find that the ten percent of funds with the lowest
expenses out performs the ten percent of funds with the highest
expenses by 0.92 percent a year. They find that for S&P 500 index
mutual funds, the incentive for brokers and financial planners to
push the fund (as represented by loads) is more important for new
flows than is avoiding high cost and poorly performing funds. They
are unable to find any effect of the quality of services on flows.
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) offer experimental evidence
that index fund investors are largely insensitive to fees.
Some other studies suggest, however, that fee levels may in fact
be competitive and efficient. Many studies fail to measure potential
non-financial benefits investors might derive from professional
investment advice. Victoria Leonard-Chambers & Michael Bogdan, Why
Do Mutual Fund Investors Use Professional Financial Advisers?,
Investment Company Institute Research Fundamentals, Volume 16,
Number 1 (April 2007) present results of a survey ``that identifies
the benefits investors say they receive from using professional
financial advisers,'' and contrast this perspective with that of
studies that rely on ``performance and other publicly available
measures to examine the value'' of such advice. Other studies find
that investors with more intelligence or financial literacy often
pay similar fees as those with less, and suggest this is consistent
with the hypothesis that fees are competitive and efficient (see,
e.g., Sebastian Miller & Martin Weber, Financial Literacy and Mutual
Fund Investments: Who Buys Actively Managed Funds?, Social Science
Research Network Abstract 1093305 (Feb. 2008); and Mark Grinblatt et
al., Are Mutual Fund Fees Competitive? What IQ-Related Behavior
Tells Us, Social Science Research Network Abstract 1087120 (Nov.
2007)).
The Department understands that some of what might otherwise
appear to be higher than necessary fees paid by investors pursuant
to advice may in fact reflect indirect payment of the reasonable
cost of the advice itself.
---------------------------------------------------------------------------
[[Page 49904]]
The Department estimates that DC plan participants \17\ and IRA
beneficiaries together recently paid fees and expenses that were higher
than necessary by $8 billion or more annually on aggregate.\18\ Good
advice could eliminate some of this unnecessary expense.\19\
---------------------------------------------------------------------------
\17\ DC plan participants' investment choices typically are
limited to a menu selected by a plan fiduciary who is responsible
for ensuring that the associated fees and expenses are reasonable.
However, such participants may pay more overall than would be
optimal if they do not appropriately consider fees and expenses when
allocating their assets across available investments.
\18\ ``Higher than necessary'' here means that the participant
could have obtained equal value without incurring the expense. This
calculation assumes that participants on average pay 11 or more
basis points in unnecessary fees and expenses, in the form of
expense ratios or loads. This assumption is likely to be
conservative in light of evidence on the distribution of investor
expense levels presented in Deloitte Financial Advisory Services
LLP, Fees and Revenue Sharing in Defined Contribution Retirement
Plans (Dec. 6, 2007) (unpublished, on file with the Department of
Labor); 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, 2095-2119 (2005); Edwin J. Elton et al.,
Are Investors Rational? Choices Among Index Funds, Social Science
Research Network Abstract 340482 (June 2002); 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); and 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). This estimate of excess expense does not take into account
less visible expenses such as mutual funds' internal transaction
costs (including explicit brokerage commissions and implicit trading
costs), which are sometimes larger than funds' expense ratios
(Deloitte Financial Advisory Services LLP, Fees and Revenue Sharing
in Defined Contribution Retirement Plans (Dec. 6, 2007)
(unpublished, on file with the Department of Labor); Jason Karceski
et al., Portfolio Transactions Costs at U.S. Equity Mutual Funds,
University of Florida Working Paper (2004), at http://
thefloat.typepad.com/the_float/files/2004_zag_study_on_mutual_
fund_trading_costs.pdf).
\19\ Conversely, there is evidence that some higher than
necessary expense currently is a direct result of what might be
called bad advice, meaning certain marketing activities carried out
by intermediaries such as brokers as well as direct consumer
advertising by vendors of funds and competing financial products.
---------------------------------------------------------------------------
Poor Trading Strategies
There is evidence that some participants trade excessively, while
many more trade too little, failing even to rebalance. In DC plans,
participant trading often worsens performance, and those with automatic
rebalancing generally fare best.\20\ Relative to automatic rebalancing,
inferior trading strategies recently cost participants perhaps $56
billion or more annually, the Department estimates.\21\ Among inferior
strategies, it is likely that active trading aimed at timing the market
generates more adverse results than failing to rebalance. Many mutual
funds investors' experience badly lags the performance of the funds
they hold because they buy and sell shares too frequently and/or at the
wrong times.\22\ Investors often buy and sell in response to short-term
past returns, and suffer as a result.\23\ Good advice is likely to
discourage market timing efforts and encourage rebalancing, thereby
ameliorating adverse impacts from poor trading strategies.
---------------------------------------------------------------------------
\20\ See, e.g., Takeshi Yamaguchi et al., Winners and Losers:
401(k) Trading and Portfolio Performance, Michigan Retirement
Research Center Working Paper WP2007-154 (June 2007).
\21\ This estimate is derived from the risk adjusted returns
attributed to participants with different trading strategies, see
id.
\22\ See, e.g., Dalbar Inc., Quantitative Analysis of Investor
Behavior 2007 (2007).
\23\ See, e.g., Rene Fischer & Ralf Gerhardt, Investment
Mistakes of Individual Investors and the Impact of Financial Advice,
Science Research Network Abstract 1009196 (Aug. 2007); Julie Agnew &
Pierluigi Balduzzi, Transfer Activity in 401(k) Plans, Social
Science Research Network Abstract 342600 (June 2006); and George
Cashman et al., Investor Behavior in the Mutual Fund Industry:
Evidence from Gross Flows, Social Science Research Network Abstract
966360 (Feb. 2007).
---------------------------------------------------------------------------
Inadequate Diversification
Investors sometimes fail to diversify adequately and thereby assume
uncompensated risk and suffer associated losses. For example, DC plan
participants sometimes concentrate their assets excessively in stock of
their employer.\24\ Relative to full diversification,\25\ employer
stock investments recently cost DC plan participants perhaps $3 billion
\26\ annually, the Department estimates.\27\ Other lapses in
diversification may involve omission from portfolios of
[[Page 49905]]
asset classes such as overseas equity or debt, small cap stocks, or
real estate. Such lapses may sometimes reflect limited investment menus
supplied by DC plans.\28\ Yet even where adequate choices are available
and company stock is not a factor, investors sometimes fail to
diversify adequately.\29\ Inadequate diversification other than
excessive concentration in company stock recently cost participants
perhaps $42 billion annually, the Department estimates.\30\ Good advice
should address over concentration in employer stock and other failures
to properly diversify.
---------------------------------------------------------------------------
\24\ See, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role
of Company Stock in Defined Contribution Plans, National Bureau of
Economic Research Working Paper W9250 (Oct. 2002); and Jeffrey R.
Brown & Scott Weisbenner, Individual Account Investment Options and
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social
Science Research Network Abstract 631886 (Dec. 2004).
\25\ This comparison should be viewed as an outer bound. Full
diversification of the same assets might not be feasible if
companies are unwilling to alter the compensation mix in this way
(see, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role of
Company Stock in Defined Contribution Plans, National Bureau of
Economic Research Working Paper W9250 (Oct. 2002)). It also neglects
some potential tax benefits of employer stock investments that might
offset losses from reduced diversification (see, e.g., Mukesh Bajaj
et al., The NUA Benefit and Optimal Investment in Company Stock in
401(k) Accounts, Social Science Research Network Abstract 965808
(Feb. 2007)).
\26\ Following findings reported in Lisa K. Meulbroek, Company
Stock in Pension Plans: How Costly Is It?, Social Science Research
Network Abstract 303782 (Mar. 2002), this estimate reflects losses
amounting to 14 percent of the employer stock's value, assuming 10
percent of DC plan assets are held in employer stock, the DC plan is
one-half of total wealth, and the holding period is 10 years. For
comparison, following findings reported in Krishna Ramaswamy,
Company Stock and Pension Plan Diversification, in The Pension
Challenge: Risk Transfers and Retirement Income Security 71, 71-88
(Olivia S. Mitchell & Kent Smetters eds., 2003), the annualized cost
of an option to receive the higher of the return on a typical
company stock or the return on a fully diversified equity portfolio
over a three-year horizon would amount to approximately $24 billion,
the Department estimates. This measure probably exaggerates the loss
to participants, however, insofar as it would preserve for the
participant the potential upside of a company stock that outperforms
the market.
\27\ These estimates neglect any behavioral impact full
diversification might have on asset allocation. There is some
evidence that investing in employer stock increases participants'
exposure to equity overall, which might increase average wealth
(see, e.g., Jack L. Vanderhei, The Role of Company Stock in 401(k)
Plans, Employee Benefit Research Institute T-133 Written Statement
for the House Education and Workforce Committee, Subcommittee on
Employer-Employee Relations, Hearing on Enron and Beyond: Enhancing
Worker Retirement Security (Feb. 2002), at http://www.ebri.org/pdf/
publications/testimony/t133.pdf).
\28\ See, e.g., Edwin J. Elton et al., The Adequacy of
Investment Choices Offered By 401(k) Plans, Social Science Research
Network Abstract 567122 (Mar. 2004), which finds that menus are
frequently inadequate, and Ning Tang and Olivia S. Mitchell, The
Efficiency of Pension Plan Investment Menus: Investment Choices in
Defined Contribution Pension Plans, University of Michigan
Retirement Research Center Working Paper WP 2008-176 (June 2008), at
http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp176.pdf,
which finds that most menus are efficient.
\29\ See, e.g., Laurent E. Calvet et al., Down or Out: Assessing
the Welfare Costs of Household Investment Mistakes, Harvard
Institute of Economic Research Discussion Paper No. 2107 (Feb.
2006).
\30\ See id. This estimate assumes annual return decrements from
inadequate diversification of 0.3 percent of invested assets for
investors that are already investing in risky assets (like stocks
and mutual funds) and 3.3% for investors that are not yet investing
in risky assets. The Department estimates that in the U.S. about 85%
of investors include risky assets in their portfolios.
---------------------------------------------------------------------------
Inappropriate Risk
Investors who avoid the foregoing three mistakes might be said to
invest efficiently, in the sense that they generally can expect the
maximum possible return given their level risk. However, they may still
be making a costly mistake: they may fail to calibrate the risk and
return of their portfolio to match their own risk and return
preferences. As a result, their investments may be too risky or too
safe for their own tastes. The Department lacks a basis on which to
estimate the magnitude of such mistakes, but believes they may be
common and large. A diversified portfolio's risk and return
characteristics generally is determined by its allocation across asset
classes. As noted above, there is ample evidence that participants'
asset allocation choices often are inconsistent with fixed or well
behaved risk and return preferences. If participants' true preferences
are in fact fixed or well behaved, then observed asset allocations,
which often appear to shift in response to seemingly irrelevant factors
(or fail to shift in response to relevant ones), certainly entail large
welfare losses.\31\ Good advice might help participants calibrate their
asset allocations to match their true preferences.
---------------------------------------------------------------------------
\31\ The potential financial effects of changes in asset
allocation hint at the likely magnitude of these welfare effects.
The Department previously has estimated that movement of DC plan
default investments from stand-alone, low-risk capital preservation
instruments to diversified portfolios that include equities will
improve investment results for a large majority of affected
individuals, increasing aggregate account balances by an estimated
$5 billion to $7 billion in 2034 (See 72 FR 60,452, 60,466 (Oct. 24,
2007)).
---------------------------------------------------------------------------
Excess Taxes
It is likely that many households pay excess taxes as a result of
disconnects between their investment and tax strategies. Households
saving for retirement must decide not only what assets to hold, but
also whether to locate these assets in taxable or tax-deferred
accounts. For example, households may be able to maximize their
expected after-tax wealth by first placing heavily taxed bonds in their
tax-deferred account and then placing lightly taxed equities in their
taxable account. A significant number of households do not follow this
practice, however. By one estimate, to fully implement this practice in
1998, U.S. households would have had to relocate some $251 billion in
assets.\32\ It is not clear, however, whether such households are in
fact making investment mistakes. In practice, this simple asset
location rule may fail to minimize taxes.\33\ As a result the
Department has no basis to estimate the magnitude of excess taxes that
might derive from DC plan and IRA participants' investment mistakes. In
any event it is unclear whether or to what extent investment advisers
would be positioned to provide advice on tax efficiency.
---------------------------------------------------------------------------
\32\ See, e.g., Daniel B. Bergstresser & James M. Poterba, Asset
Allocation and Asset Location: Household Evidence from the Survey of
Consumer Finances, Journal of Public Economics, Volume 88 1893,
1893-1915 (2004).
\33\ For example, tax-exempt municipal bonds are available, and
actively managed equity mutual funds are not always tax-efficient
(see, e.g., James M. Poterba et al., Asset Location for Retirement
Savers, in Public Policies and Private Pensions 290, 290-331 (John
B. Shoven et al. eds., 2004); and John B. Shoven & Clemens Sialm,
Asset Location in Tax-Deferred and Conventional Savings Accounts,
Journal of Public Economics, Volume 88 (2003)). Using historical
returns data and tax rate data for the period 1962-98, James M.
Poterba et al., Asset Location for Retirement Savers, in Public
Policies and Private Pensions 290, 290-331 (John B. Shoven et al.
eds., 2004) find that when investing in actively managed mutual
funds, and with the availability of tax-exempt bonds, households
would have more after-tax wealth in most cases if they had first
placed equities in the tax-deferred account. Gene Amromin, Portfolio
Allocation Choices in Taxable and Tax-Deferred Accounts: An
Empirical Analysis of Tax-Efficiency, Social Science Research
Network Abstract 302824 (May 2002) describes how accessibility
restrictions on assets in tax-deferred retirement accounts create a
tension between making tax-efficient placements and the risk of
having to make costly withdrawals in the event of a bad labor income
shock. He presents empirical evidence that holding apparently tax-
inefficient portfolios is related to accessibility restrictions and
to precautionary motives. Lorenzo Garlappi & Jennifer C. Huang, Are
Stocks Desirable in Tax-Deferred Accounts?, Journal of Public
Economics, Volume 90 2257, 2257-2283 (July 2006) explain how a tax-
deferred account essentially confers a tax subsidy onto its
holdings. While the level of the tax subsidy may be maximized by
first placing bonds in the tax-deferred account, this strategy may
lead to a more volatile tax benefit. Risk-averse households may wish
to smooth this volatility by holding a mix of equities and bonds in
both tax-deferred and taxable accounts, as some are observed to do
in practice. Robert M. Dammon et al., Optimal Asset Location and
Allocation with Taxable and Tax-Deferred Investing, The Journal of
Finance, Volume LIX, Number 3 999, 999-1037 (2004) find that even
when tax-exempt bonds are available and even when there are
liquidity shocks, for most investors it is best to put taxable bonds
in the tax-deferred account and equity in the taxable account.
---------------------------------------------------------------------------
Promoting Investment Advice
Permissible Arrangements
Federal law limits the variety of arrangements whereby participants
may obtain investment advice. Specifically, ERISA and the Internal
Revenue Code generally prohibit fiduciaries from dealing with DC plan
or IRA assets in ways that advance their own interests. These
provisions effectively preclude participants from obtaining advice
under arrangements that are widely used by other investors. For
example, under many common arrangements, the adviser may receive a
commission or other consideration when the investor enters into a
transaction pursuant to the advice. The adviser's employer or an
affiliate thereof may receive a sales load or other consideration in
connection with the transaction. Stated generally, many common
investment advice arrangements present financial advisers with
opportunities to self deal.
While generally prohibiting arrangements that present such
opportunities, federal law also provides for conditional exemptions
whereby otherwise prohibited transactions are permitted. Some
exemptions are contained in the statute. The Department has authority
to grant others. The conditions attached to such exemptions serve to
mitigate the adverse effects of the conflicts of interest that are
present and thereby protect participants' interests. However, the
Department invites suggestions for other safeguards against conflicts
of interest that would be consistent with the goal of making quality
advice more widely available.
The Pension Protection Act of 2006 opened the door to more types of
investment advice arrangements by conditionally permitting arrangements
where the fiduciary adviser or an affiliate thereof has a financial
stake in
[[Page 49906]]
the advised participants' investment decisions. The Department is
proposing a regulation to further specify the PPA's applicable
conditions, together with a class exemption to establish alternative
conditions under which such arrangements may operate. Table 1
summarizes the effect of the PPA and this proposed class exemption on
permissible investment advice arrangements.
The Department calibrated this proposed regulation to in an effort
to protect participants while promoting the affordability of investment
advice arrangements operating pursuant to the PPA's statutory exemptive
relief, in order that such arrangements will proliferate and thrive, to
the benefit of participants.
The PPA's relief (listed at B. in table 1) is conditioned in part
on audits. In order to promote the affordability of advice, this
proposed regulation provides that audits may rely on a representative
sample of similar arrangements. In order to protect participants, this
proposed regulation requires that audit reports identifying
noncompliance in connection with advice provided to IRA beneficiaries
be furnished to the Department.
1--Permissible Investment Advice Arrangements
----------------------------------------------------------------------------------------------------------------
Is it permissible for compensation
to vary depending on participants' Person providing Fiduciary adviser Fiduciary advisers'
investment decisions? advice entity affiliates
----------------------------------------------------------------------------------------------------------------
A. Absent any exemptive relief:
1. Except as described at 2. No...................... No..................... No.
below.
2. Advice is determined solely N/a *................... Yes.................... Yes.
by a computer model that is
provided by an independent
entity and over which the
fiduciary adviser has no
control.
B. Under PPA statutory exemption:
1. Subject to conditions No...................... No..................... Yes.
including authorization by a
separate fiduciary, independent
audits, disclosure, and
recordkeeping.
2. Subject to conditions listed N/a *................... Yes.................... Yes.
above at 1., and advice is
provided by a computer model
that is certified by an
independent expert and
satisfies conditions including
conformance to investment
theories and objectivity.
C. Under proposed class exemption:
1. Subject to conditions No...................... Yes.................... Yes.
including conformance to
investment theories,
authorization by a separate
fiduciary, independent audits,
disclosure, and recordkeeping.
2. Subject to conditions listed Yes..................... Yes.................... Yes.
above at 1. and additional
conditions including prudence
and loyalty, advance provision
of benchmark recommendations or
educational material, and
documentation.
----------------------------------------------------------------------------------------------------------------
* Under these arrangements, the investment advice is formulated exclusively by use of the computer model.
The PPA's statutory exemptive relief for investment advice
arrangements that use computer models (listed at B.2. in table 1) is
conditioned in part on independent expert certification of such models.
The expert must meet requirements specified by the Secretary and
certifications and renewals thereof must be completed in accordance
with rules established by the Secretary. This proposed regulation
establishes such requirements and rules.
In advance of formulating these requirements and rules the
Department invited and considered extensive public input on the nature,
functions, and performance of existing models. The Department also
closely examined and road tested some popular models with particular
attention to the criteria set forth in section 408(g)(3)(B) of ERISA.
The Department came to the conclusion that existing computer models can
take into account various information about individuals, their
preferences and available investment options and, in its limited
attempt to examine whether recommendations provided were optimal, the
Department did not find evidence of computer models recommending
investment portfolios that have risk return profiles inferior to any
individual investment alternative available.
On these bases the Department understands that models capable of
satisfying the exemption's conditions are various and evolving. The
variety and evolution reflect healthy competition to develop superior
products that deliver more value to participants.
The Department sought to calibrate this proposed regulation to
nurture such competition while keeping advice affordable and protecting
participants' interests. This proposed regulation consequently provides
for transparency and procedural rigor but generally does not attempt to
specify precise and fixed substantive standards. For example, pursuant
to the proposed regulation the experts' qualifications will be reviewed
by a fiduciary, and each certification will be documented in detail.
The proposed regulation also provides that models may be certified once
for similar applications across multiple DC plans or IRAs, rather than
separately for each individual application, thereby promoting
affordability of arrangements using models.
The Department likewise sought to calibrate this proposed class
exemption to protect participants while promoting the affordability of
investment advice arrangements operating pursuant to it, in order that
such arrangements likewise will proliferate and thrive, to the benefit
of participants. As detailed below, the proposed class exemption, by
relaxing bars against arrangements that place fiduciary advisers in
positions where they have potential conflicts of interest, will
increase the variety of investment advice arrangements that are
available and potentially lower the cost and promote the marketing of
such arrangements, to the benefit of participants. Conditions attached
to the proposed class exemption will mitigate the adverse impact of the
conflicts and thereby ensure the quality of advice provided pursuant to
it.
Availability and Use
Participants have always had the option of obtaining permissible
investment advice services directly in the retail market. DC plan
sponsors likewise have had the option of obtaining such services in the
commercial market and making them available to plan participants and
beneficiaries in connection with the plan.
Prior to the 2006 enactment of the PPA, a substantial fraction of
DC plan sponsors already made investment advice available to plan
participants and
[[Page 49907]]
beneficiaries. Today, as the PPA's implementation progresses, many more
have begun providing or are gearing up to provide such advice. It is
likely that 40 percent or more of DC plan sponsors currently provide
access to investment advice either on line, by phone, or in-person.
Where offered, approximately 25 percent of participants use advice. In-
person advice seems to be offered by the most plan sponsors. On-line
advice and to a lesser degree telephone advice are favored more by
large sponsors. Smaller plan sponsors appear to offer advice generally
and in-person advice in particular more frequently than larger plan
sponsors.\34\
---------------------------------------------------------------------------
\34\ This assessment is based on the Department's reading of
Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement,
2007 (2007); Profit Sharing/401(k) Council of America, 50th Annual
Survey of Profit Sharing and 401(k) Plans (2007); and Deloitte
Development LLC, Annual 401(k) Benchmarking Survey, 2005/2006
Edition (2006). In addition to investment advice, a majority of
sponsors also provide one or more other types of support to
participants' investment decisions. Other types of support include
providing general investment education via seminars or written
materials, offering one-stop, pre-mixed investment alternatives such
as lifestyle funds, and offering managed accounts.
---------------------------------------------------------------------------
Investment advice is also already used by a substantial fraction of
IRA participants, the Department believes. A majority of IRA
participants that invest in mutual funds purchase some or all of their
funds via a professional financial adviser.\35\ Overall 60 percent of
U.S. workers and retirees say they use the advice of a financial
professional when making retirement savings and investment decisions;
40 percent say this advice was more helpful to them than
alternatives.\36\ It is not clear how recently this advice was
obtained, however: In the same survey just 28 percent say that in the
past year they obtained investment advice from a professional financial
adviser who was paid through fees or commissions.\37\
---------------------------------------------------------------------------
\35\ Eighty-two percent of mutual fund shareholders who hold
funds outside of DC plans purchase some or all of their funds from a
professional financial adviser such as a full-service broker,
independent financial planner, bank or savings institution
representative, insurance agent, or accountant (see, e.g., Victoria
Leonard-Chambers & Michael Bogdan, Why Do Mutual Fund Investors Use
Professional Financial Advisers?, Investment Company Institute
Research Fundamentals, Volume 16, Number 1 (April 2007)). Because
families owning IRAs outnumber those owning pooled investment
vehicles outside of retirement accounts (see, e.g., Brian K. Bucks
et al., Recent Changes in U.S. Family Finances: Evidence from the
2001 and 2004 Survey of Consumer Finances, Federal Reserve Bulletin
92 A1, A1-A38 (2006)), it is reasonable to conclude that a large
majority of IRA beneficiaries who invest in mutual funds purchase
them via such professionals. The Department has no basis to estimate
the fraction of these beneficiaries that receive true investment
advice from such professionals, however. It is possible that some
make their purchase decisions without receiving any recommendation
or material guidance from the professional making the sale.
\36\ Alternatives including advice of peers, written plan
materials, print media, television and radio, seminars, software,
on-line information or advice, and retirement benefit statements
were all less likely to be characterized as ``most helpful.''
\37\ See, e.g., Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007).
---------------------------------------------------------------------------
The new statutory exemptive relief provided by the PPA is expected
to increase the availability of advice, but it is too early to observe
by how much.\38\ The Department believes that absent this proposed
class exemption some segments of the plan and participant market will
lack adequate access to quality, affordable investment advice. Some
potential fiduciary advisers will be deterred from entering the market
by the complexity of advice arrangements that conform to the conditions
of the PPA's statutory exemptive relief.\39\ Some plan sponsors and
participants will be deterred by the cost of such arrangements,\40\ or
by dissatisfaction with the types of advice arrangements that are
available at lower costs, such as automated computer investment advice
programs.\41\ As a result some DC plan sponsors will not offer advice,
and where it is offered some participants will not use it.\42\ IRA
beneficiaries may face similar obstacles to obtaining affordable,
quality investment advice.
---------------------------------------------------------------------------
\38\ The statutory exemptive relief for investment advice
provided by the PPA generally became effective for advice provided
after December 31, 2006. In February 2007 EBSA issued guidance on
the new statutory exemptive relief for arrangements using fiduciary
advisers whose affiliates' revenue might vary depending on the
fiduciary advisers' fiduciary acts. It is likely that some such
arrangements exist today, and that more will in the future. The PPA
also provided relief for arrangements that provide advice via
independently certified computer models. The PPA withheld this
exemptive relief in connection with IRAs, however, unless and until
the Department found and reported to Congress that a model
satisfying certain criteria exists. Concurrent with issuance of this
proposed class exemption, the Department has reached this finding
and reported it to Congress. Therefore statutory relief for this
latter type arrangement is just now being extended to IRAs. In
addition, the PPA provides that the Department will by regulation
specify the process by which computer models will be certified.
Concurrent with issuance of this proposed class exemption, the
Department is proposing such a regulation. Given this timing it is
unlikely that many such latter type arrangements yet exist.
\39\ Such complexity can include the need to enlist an adviser
who is independent of or merely affiliated with the plan's or IRA's
investment manager, in order to avoid direct exposure of the adviser
to potential conflicts.
\40\ As discussed below, arrangements that avoid potential
conflicts may entail higher or more visible costs.
\41\ In one survey of DC plan sponsors, among those offering
investment advice, ``access to financial counselors in person'' was
rated most effective, followed by ``access to financial counselors
via telephone.'' ``Web-based'' advice received the lowest
effectiveness ratings (see, e.g., Deloitte Development LLC, Annual
401(k) Benchmarking Survey, 2005/2006 Edition (2006)). This finding
is corroborated by another survey, in which in-person advice appears
to be used by participants more often than advice delivered via the
Internet (see, e.g., Profit Sharing/401(k) Council of America,
Investment Advice Survey 2001 (2001)).
\42\ Where investment advice is available to DC plan
participants, only one in four uses it, according to one plan
sponsor survey (see, e.g., Profit Sharing/401(k) Council of America,
50th Annual Survey of Profit Sharing and 401(k) Plans (2007)). On-
line advice appeals more to higher-salaried, full-time workers (see,
e.g., Julie Agnew, Personalized Retirement Advice and Managed
Accounts: Who Uses Them and How Does Advice Affect Behavior in
401(k) Plans?, Center for Retirement Research Working Paper 2006-9
(2006)). In one survey, two-thirds of workers and 85 percent of
retirees expressed discomfort with ``obtaining advice from financial
professionals on-line. This raises the possibility that many
participants, perhaps especially lower-paid, part-time participants,
may be underserved if the regulatory environment excessively favors
on-line advice.
---------------------------------------------------------------------------
From the point of view of DC plan sponsors, the PPA and this
proposed class exemption could help relieve certain concerns that have
impeded some from providing investment advice in the past. A few years
prior to the enactment of the PPA less than one in four surveyed DC
plan sponsors provided advice, according to one survey.\43\ Those not
providing advice were asked to cite reasons and rate the reasons'
importance on a 0-to-5 scale. Two reasons cited by large majorities and
rated moderately important might be ameliorated by this proposed class
exemption: ``Fiduciary concern about ensuring that the advice provider
has no conflict of interest'' \44\ (cited by 84 percent and rated 3.1)
and ``cost of providing advice'' \45\ (cited by 69 percent and rated
2.0).\46\ In another pre-PPA survey 35 percent of DC plan sponsors not
offering advice cited cost as a reason.\47\
---------------------------------------------------------------------------
\43\ See, e.g., Profit Sharing/401(k) Council of America,
Investment Advice Survey 2001 (2001).
\44\ Both the PPA and this proposed class exemption extend
conditional relief from ERISA's prohibited transaction provisions,
but neither relieves plan fiduciaries of their general obligations
under ERISA.
\45\ The cost of advice is discussed further immediately below.
\46\ Other fiduciary concerns, cited more frequently and rated
more important, are not addressed by this proposed class exemption.
\47\ See, e.g., Deloitte Development LLC, Annual 401(k)
Benchmarking Survey, 2005/2006 Edition (2006).
---------------------------------------------------------------------------
From the point of view of prospective fiduciary advisers whose
business models involve conflicts--e.g., who are compensated by the
companies that manufacture, manage, and/or trade the investment
products that they recommend--the PPA and this proposed class exemption
grant conditional access to a very large and
[[Page 49908]]
fast growing new market segment.\48\ These advisers might be in a
position to offer their services at low or no direct cost to the
companies' DC plan and IRA clients (relying instead on compensation
from the companies). They might market their services to the companies'
clients more actively than have independent advisers historically.
---------------------------------------------------------------------------
\48\ Combined participant directed DC plan and IRA assets exceed
$7 trillion.
---------------------------------------------------------------------------
For purposes of this impact assessment, the Department anticipates
that owing to the statutory exemptive relief provided by the PPA,
advice of some type (on-line, telephone and/or in person) will soon be
available to perhaps one-half of DC plan participants, with in-person
advice available to perhaps one in four. This proposed class exemption
will boost these fractions to perhaps 60 percent and 35 percent,
respectively. The Department's assumptions are summarized in Table
2.\49\
---------------------------------------------------------------------------
\49\ The Department based its assumptions on its reading of
Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement,
2007 (2007); Profit Sharing/401(k) Council of America, 50th Annual
Survey of Profit Sharing and 401(k) Plans (2007); and Deloitte
Development LLC, Annual 401(k) Benchmarking Survey, 2005/2006
Edition (2006).
2--Availability of Advice to DC Plan Participants
------------------------------------------------------------------------
Any advice
(computer Live
Policy context or live) advisor
(percent) (percent)
------------------------------------------------------------------------
Pre-PPA....................................... 40 20
PPA........................................... 50 25
Class exemption............................... 60 35
------------------------------------------------------------------------
The effect of investment advice depends not merely on its
availability but on its use by DC plan and IRA participants. Do the
participants seek advice, and if so do they follow it? According to one
survey, among DC plan participants offered investment advice,
approximately one in four uses it. There is some evidence that
historically in-person advice has achieved higher use rates than on-
line advice, with on-line advice appealing more to higher-income
participants.\50\ In another survey large fractions of workers say they
would be very likely (19 percent) or somewhat likely (35 percent) to
take advantage of advice provided by the company that manages their
employer's DC plan. Of these, two-thirds said they would implement only
those recommendations that were in line with their own ideas; 21
percent said they would implement all of the recommendations as long as
they trusted the source.\51\ In a subsequent survey, among those
obtaining investment advice, 36 percent say they implemented ``all'' of
the advice, 58 percent ``some,'' and just 5 percent ``none.'' \52\
---------------------------------------------------------------------------
\50\ See, e.g., Profit Sharing/401(k) Council of America, 50th
Annual Survey of Profit Sharing and 401(k) Plans (2007); and Julie
Agnew, Personalized Retirement Advice and Managed Accounts: Who Uses
Them and How Does Advice Affect Behavior in 401(k) Plans?, Center
for Retirement Research Working Paper 2006-9 (2006).
\51\ See, e.g., Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007). In practice this might translate into a high rate of
compliance with recommendations, if recommendations turn out not to
diverge too much from participants' own ideas.
\52\ See, e.g., Employee Benefit Research Institute, 2008
Retirement Confidence Survey, Wave XVIII, Posted Questionnaire (Jan.
2008).
---------------------------------------------------------------------------
The PPA and this proposed class exemption together could boost DC
plan participants' use of advice where offered, in at least two ways.
First, because it appears that in-person advice arrangements are more
heavily used than automated computer advice programs, wider
availability of in-person advice programs wherein advisers can exercise
discretion in formulating personalized advice (rather than merely
communicate the recommendations of a computer model)--a likely
consequence of this proposed class exemption--might be expected to
boost use rates. The shift anticipated by the Department (discussed
immediately above) would increase the use rate slightly from 25 percent
to 26 percent.\53\ Second, if the cost of advice falls, participants
who must pay for advice will become more inclined to use it. However,
historically employers have usually paid directly for advice, or passed
the cost to all participants whether they use advice or not,\54\ and as
explained below it is unclear by how much the cost of advice will fall.
Therefore for purposes of this impact assessment the Department did not
take into account any cost-driven increase in use of advice by DC plan
participants, but assumed that this proposed class exemption will
increase the fraction of DC plan participants using advice where
available from 25 percent to 26 percent.\55\ Given the Department's
assumptions regarding availability of advice to DC plan participants,
this translates into an increase in the incidence of advice due to this
proposed class exemption from 10 percent to 16 percent.
---------------------------------------------------------------------------
\53\ This assumes that the use rate for where in person advice
is available is approximately 50 percent higher (30 percent) as
where only on-line or telephone advice is available (20 percent)
(see, e.g., Employee Benefit Research Institute, 2007 Retirement
Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 2007)).
\54\ See, e.g., Profit Sharing/401(k) Council of America,
Investment Advice Survey 2001 (2001).
\55\ One survey found that 64 percent of workers already use
professional financial advice when making retirement savings and
investment decisions, and that 54 percent are very or somewhat
likely to use advice if offered by their employer in connection with
a DC plan (see, e.g., Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007)). This seems to suggest a higher baseline rate of advice use
than assumed here. However, because the latter fraction is smaller
than the former, it is unclear whether this suggests that this
proposed class exemption would increase DC plan participants' use of
advice by more or less than assumed here.
---------------------------------------------------------------------------
The PPA and this proposed class exemption could also boost IRA
participants' use of advice. As noted above, advisers doing business
pursuant to this class exemption are likely to actively market advice
services to IRA participants and to offer them reduced prices for such
services. The reduced prices will reflect both the availability to
advisers of other compensation and possible cost saving in the
production and delivery of advice. Advisers doing business pursuant to
this proposed class exemption may thereby attract business both from
IRA participants who otherwise would be without advice and from IRA
participants who otherwise would obtain advice through an arrangement
that does not require the relief provided by this proposed class
exemption. IRA participants who would otherwise be without advice may
obtain advice in response to such marketing and pricing activity
because the activity reduces their search cost to find and select an
adviser, and/or because the reduced price falls below their reservation
price. Likewise, IRA participants who would otherwise have obtained
advice via some other arrangement may switch to an arrangement pursuant
to the PPA or this proposed class exemption (and may increase the
amount of advice services they use) because the advisers' marketing
activity broadens their search and/or in pursuit of lower prices.
In proposing this class exemption the Department considered
carefully the importance of transparency in pricing. Participants'
decisions whether and where to obtain advice should be well informed
with respect to the cost associated with alternative arrangements. As a
condition of this proposed class exemption an adviser must disclose to
the participant certain information regarding other revenue sources.
This condition is intended to enable participants to decide whether,
where, and how much advice to obtain, in light of the associated direct
and indirect costs to them.\56\ Therefore the
[[Page 49909]]
Department intends that any cost-driven increase in use of advice by
IRA participants will be driven by overall cost decreases and not
solely by direct price reductions.
---------------------------------------------------------------------------
\56\ In particular, participants should be able to adequately
compare the prices offered by advisers doing business pursuant to
this exemption with those offered by other advisers such as those
offering their services for a flat fee.
---------------------------------------------------------------------------
As noted above there is evidence that a large fraction of IRA
participants already use advice. For purposes of this assessment the
Department assumes that as a result of the PPA and this proposed class
exemption the proportion of IRA beneficiaries using advice will
increase from one-third to two-thirds. The Department's assumptions
regarding use of advice are summarized in table 3.\57\
---------------------------------------------------------------------------
\57\ These assumptions are based on the Department's reading of
Employee Benefit Research Institute, 2007 Retirement Confidence
Survey, Wave XVII, Posted Questionnaire (Jan. 2007); Hewitt
Associates LLC, Survey Findings: Hot Topics in Retirement, 2007
(2007); Profit Sharing/401(k) Council of America, 50th Annual Survey
of Profit Sharing and 401(k) Plans (2007); and Deloitte Development
LLC, Annual 401(k) Benchmarking Survey, 2005/2006 Edition (2006).
There are a number of reasons to believe that use of advice will be
higher among IRA beneficiaries than DC plan participants. The
aforementioned survey reports, read together, generally support this
conclusion. In addition, relative to IRA beneficiaries, DC
participants may have less need for advice and/or easier access to
alternative forms of support for their investment decisions. DC plan
participants' choice is usually confined to a limited menu selected
by a plan fiduciary, and the menu may include one-stop alternatives
such as target date funds that may mitigate the need for advice.
Their plan or employer may provide general financial and investment
education in the form of printed material or seminars. They often
make initial investment decisions (sometimes by default) before
contributing to the plan so the decisions' impact may seem small.
Finally, the availability of advice in connection with the plan is
intermediated by the plan sponsor and fiduciary. In contrast, IRA
beneficiaries generally have wider choice and are more likely to be
without employer-provided support for their decisions. Decision
points may more often occur when account balances are large, such as
when rolling a large DC plan balance into an IRA or when retiring.
Finally, the availability of advice to IRA beneficiaries is not
intermediated by an employer--rather IRA beneficiaries interface
directly with the retail market and will thereby be more directly
affected by the exemptive relief provided by the PPA and by this
proposed class exemption. For all of these reasons IRA beneficiaries
may use advice more frequently than DC plan participants.
3--Use of Advice by DC Plan and IRA Participants
----------------------------------------------------------------------------------------------------------------
DC plans
-------------------------------- Dollars
Policy context Where offered Overall IRA advised
(percent) (percent) ($trillions)
----------------------------------------------------------------------------------------------------------------
Pre-PPA......................................... 25 10 33 $1.7
PPA............................................. 25 13 50 2.5
Class exemption................................. 26 16 67 3.2
----------------------------------------------------------------------------------------------------------------
It seems likely that in practice a large proportion of participants
who receive advice will follow that advice either in whole or in part.
This is especially likely if the advice turns out to be broadly in line
with the participants' own thinking. Nonetheless, some advice will not
be followed, and as a result some investment errors will not be
corrected. For purposes of this analysis, the Department has assumed
that advised participants make investment errors at one-half the rate
of unadvised participants. The remaining errors reflect participant
failures to follow advice (together with possible flaws in some advice,
as discussed immediately below).
Cost
As noted above the PPA and this proposed class exemption are
expected to make advice available to participants at a lower direct
price, because advisers will be able to rely on alternative revenue
sources to compensate their efforts. More importantly, however, the
Department believes that the total cost of the advice to participants
will be reduced. Bars against transactions wherein fiduciary advisers'
and participants' interests may conflict carry costs. Faced with such
bars advisers may forgo certain potential economies of scale in
production and distribution of financial services that would derive
from more vertical and horizontal integration.\58\ And to avoid such
conflicts they must carefully monitor and calibrate their relationships
and compensation arrangements, or incur the opportunity cost associated
with exclusive reliance on level fees. The Department therefore expects
the PPA and this proposed class exemption to produce cost savings by
harnessing economies of scale and by reducing compliance burdens. The
Department is unaware of any available empirical basis on which to
determine whether or by how much costs might be reduced, however.
---------------------------------------------------------------------------
\58\ For example, an adviser employed by an asset manager can
share the manager's research instead of buying or producing such
research independently.
---------------------------------------------------------------------------
Quality
The effect of investment advice also depends on its quality. Good
advice can reduce investment errors, steering investors away from
higher than necessary expenses and toward optimal trading strategies,
broad diversification, and asset allocations consistent with the
investors' tastes for risk and return. The Department believes that,
although there is no universally accepted single and complete theory of
optimal investing, and although there is some evidence of lapses in the
quality investment advice,\59\ professional advisers'
[[Page 49910]]
recommendations are likely to be superior to unadvised participants'
investment practices.\60\ It is therefore likely that participants who
obtain and follow advice, including advice provided pursuant to the PPA
or this proposed class exemption and advice provided under alternative
permissible arrangements, will substantially reduce their investment
mistakes and thereby derive substantial financial benefits and improve
their welfare.
---------------------------------------------------------------------------
\59\ There is no single, complete, universally accepted theory
of optimal investment. Instead there are competing and evolving
theories which have much in common (what might be called ``generally
accepted'' theories) but also important differences (see, e.g.,
Martin Wallmeier & Florian Zainhofer, How to Invest Over the Life
Cycle: a Review, Social Science Research Network Abstract 951167
(Dec. 2006); and Deloitte Financial Advisory Services LLP, Generally
Accepted Investment Theories (July 11, 2007) (unpublished
memorandum, on file with the Department of Labor)). In practice this
means that different experts may give different advice; often the
differences will be small but occasionally they might be large.
There is some evidence of lapses in the quality of investment
advice. Investment advisers' advice does not always conform to
generally accepted investment theories. For example, they sometimes
neglect investors' debt, or exhibit ``home bias'' toward domestic
investment. Home bias may be larger in advice given to more risk
averse investors; this conflicts with theory insofar as home bias
reduces diversification and therefore increases risk. Investment
advisers in some sense have two functions: to provide investment
advice and to provide investor advice. The former ought to conform
to financial theories, while the latter involves helping investors
overcome behavioral biases and errors. Together these functions may
result in a nuanced balance between what the investor theoretically
``should'' choose and what the investor is comfortable choosing
(see, e.g., Elisa Cavezzali & Ugo Rigoni, Investor Profile and Asset
Allocation Advice, Social Science Research Network Abstract 966178
(Feb. 2007)). Some advice computer models and educational material
may furnish misleading information regarding risk and consequently
may do harm (see, e.g., Zvi Bodie, An Analysis of Investment Advice
to Retirement Plan Participants, in The Pension Challenge: Risk
Transfers and Retirement Income Security 19, 19-32 (Olivia S.
Mitchell & Kent Smetters eds., 2003)). Advice computer models
generally fail to coordinate financial investments with financial
risks associated with individuals' jobs, homes, and health (see,
e.g., John Ameriks & Douglas Fore, Financial Planning: On the Issue
of Advice, Benefits Quarterly, Fourth Quarter 6, 6-14 (2002)). While
it is widely agreed that such coordination is important, theories
about how this should be done continue to evolve (see, e.g.,
G[uuml]nter Franke et al., Non-Market Wealth, Background Risk and
Portfolio Choice, Social Science Research Network Abstract 968096
(Mar. 2007)). Typical advice as reflected in target-date funds
conforms to some financial theories but conflicts with others (see,
e.g., Luis M. Viceira, Life-Cycle Funds, Social Science Research
Network Abstract 988362 (May 2007)).
\60\ Rene Fischer & Ralf Gerhardt, Investment Mistakes of
Individual Investors and the Impact of Financial Advice, Science
Research Network Abstract 1009196 (Aug. 2007) ``present financial
advice as (potentially) correcting'' a variety of investment
mistakes that left uncorrected ``lead to considerable welfare
losses.''
---------------------------------------------------------------------------
In its effort to ensure the quality of advice, the Department
carefully considered the substantial risks attendant to opportunities
for self-dealing that may exist among fiduciary advisers doing business
pursuant to the PPA or this proposed class exemption. There is evidence
that advisers sometimes seize such opportunities and thereby reap
profit at investors' expense.\61\ The provisions of this proposed
regulation and conditions attached to this proposed class exemption are
intended to guard against these risks while keeping advice
affordable.\62\
---------------------------------------------------------------------------
\61\ These risks consist of the possibility that some advisers
will pursue profit by dispensing advice that increases their own
revenue at the expense of participants' interests.
Consideration of these risks is especially important because
advice pursuant to this proposed class exemption, while extending to
many participants who otherwise would invest without guidance or
support, may also extend to many others who absent this class
exemption would have benefited from alternative forms of support for
their investment decisions, such as alternative permissible advice
arrangements, target-date funds, managed accounts, or automatic
rebalancing.
In considering these risks the Department devoted separate
attention to the application of this proposed class exemption to
IRAs. In contrast to DC plan participants, IRA participants may be
more vulnerable to risks attendant to conflicts of interest insofar
as they: (1) May include more retirees, who may be in greater need
of advice, but who also may be more vulnerable to abusive practices
(see, e.g., Phyllis C. Borzi & Martha Priddy Patterson, Regulating
Markets for Retirement Payouts: Solvency, Supervision and
Credibility, Pension Research Council Working Paper PRC WP2007-21
(Sept. 2007)); (2) are not represented by a plan fiduciary,
independent of the adviser and connected to their interests via an
employment relationship, who selects and monitors the advice
arrangement and pre-screens the menu of investment options for
quality; and (3) may not, under the conditions of this proposed
class exemption, have the benefit of specific advice provided by an
independent or independently-certified computer model to compare
with (and possibly follow in lieu of) advice delivered pursuant to
the proposed class exemption. In addition, while advisers to DC plan
participants are subject to standards of fiduciary conduct and
attendant liability under Title I of ERISA, advisers to IRA
beneficiaries are not. Finally, the Department's authority to
enforce the conditions of this proposed exemption generally extends
only to DC plans and not to IRAs. On the other hand, IRA
beneficiaries' vulnerability to risks attendant to conflicts of
interest may be mitigated by their ability to make rational and well
informed purchases in a vibrant, competitive market for investment
advice and other financial products and services in which some
vendors will offer unconflicted advice.
The Department believes that absent effective controls conflicts
can sometimes bias advice, although it is unclear how much or in
exactly what ways. Biased advice may be less beneficial to investors
than unbiased advice, or possibly even harmful in some cases.
There is a theoretical basis to believe that investors may be
harmed (or may benefit less) where managers pay intermediary
advisers for inflows, and that such payments may increase the role
of intermediaries (fewer investors may invest directly) (see, e.g.,
Neal M. Stoughton et al., Intermediated Investment Management,
Social Science Research Network Abstract 966255 (Mar. 2007)). This
suggests that advisers whose fees are not level relative to their
clients' investment elections may give biased advice that enriches
managers at investors' expense (the motivation for and potential to
profit from conflicts and bias may attach more to the manager who
compensates the adviser than to the adviser). It also suggests that
advisers doing business pursuant to this proposed class exemption
might displace alternative forms of investment decision support.
According to one empirical study, ``there exists conflict of
interests between load fund investors and brokers and financial
advisers: brokers and financial advisers apparently serve their own
interests by guiding investors into funds with higher loads, which
generate higher income to the brokers and financial advisers but
increase the expenses of investors.'' High load funds have larger
inflows than low load funds with otherwise similar performance.
Recent increases in fund loads suggest that funds are seeking favor
from brokers and advisers (see, e.g., 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).
Another study reaches similar conclusions. ``Relative to direct-sold
funds, broker-sold funds deliver lower risk-adjusted returns, even
before subtracting distribution costs. * * * Further, broker-sold
funds exhibit no more skill at aggregate-level asset allocation than
do funds sold through the direct channel.'' Even before accounting
for the higher distribution expenses, the underperformance cost
investors $4.6 billion in 2004. Brokers devote more effort to
selling funds that generate more revenue for them (see Daniel B.
Bergstresser et al., Assessing the Costs and Benefits of Brokers in
the Mutual Fund Industry, forthcoming in The Review of Financial
Studies).
Yet another study finds that ``investors who transact through
investment professionals that are compensated through conventional
distribution channels incur substantially poorer timing performance
than investors who purchase pure no load funds.'' The
underperformance amounts to approximately 100 or 150 basis points
(see, e.g., Mercer Bullard et al., Investor Timing and Fund
Distribution Channels, Social Science Research Network Abstract
1070545 (Dec. 2007)).
Some other studies are less conclusive. For example, one finds
that captive brokers add more value for investors in purchasing
funds, while unaffiliated brokers add the most value in redeeming
them. Direct, no-load investors' redemptions are the least sensitive
to performance. This study also finds that higher payments from fund
companies to unaffiliated brokers buys some inflows for funds (see,
e.g., Susan Christoffersen et al., The Economics of Mutual-Fund
Brokerage: Evidence from the Cross Section of Investment Channels,
Social Science Research Network Abstract 687522 (Dec. 2005)).
\62\ The Department has no basis to estimate how much risk might
remain. However the Department notes that the safeguards associated
with the PPA and this class exemption are likely to be stronger than
those associated with available research studies, cited above, that
quantify substantial losses to investors. First, advisers to DC plan
participants are subject to ERISA's fiduciary standards. Second, the
PPA and this class exemption provide substantive conditions
including unbiasedness, together with procedural protections such as
provision of advice generated by computer models that are certified
by independent experts, documentation of bases for advice, and
audits of investment advice programs' conformance to applicable
substantive conditions. Such protections generally are not provided
in other U.S. contexts. For a discussion of protections applicable
where advice is delivered by investment advisers or brokers to
investors outside of IRAs and ERISA-covered retirement plans, see
Angela A. Hung et al., Investor and Industry Perspectives on
Investment Advisers and Broker-Dealers, RAND Corporation Technical
Report (2008), at http://www.sec.gov/news/press/2008/2008-1_
randiabdreport.pdf.
---------------------------------------------------------------------------
For purposes of this analysis, the Department has assumed that
advised participants make investment errors at one-half the rate of
unadvised participants. The remaining errors reflect possible flaws in
some advice (together with participant failures to follow advice,
discussed immediately above).\63\ Additionally for purposes of this
analysis the Department assumes that all permissible advice
arrangements (including those operating pursuant to exemptive relief
provided by the PPA and those operating pursuant to this proposed class
exemption) deliver
[[Page 49911]]
advice of similar quality and effectiveness.
---------------------------------------------------------------------------
\63\ Whether advice corrects errors depends on whether the
advice is followed and whether it is good. There is reason to
believe that many people receiving advice will follow it. In a 2008
survey, among those obtaining investment advice, 36 percent say they
implemented ``all'' of the advice, 58 percent ``some,'' and just 5
percent ``none'' (Employee Benefit Research Institute, 2008
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2008)). There is also reason to believe that good advice will be
available. According to Bluethgen, et al., High-Quality Financial
Advice Wanted!, Social Science Research Network Abstract 1102445
(Feb. 2008), ``There is a high degree of heterogeneity in quality
among financial advisors * * * the extent to which advisors receive
compensation in the form of fixed fees instead of sales commissions
as well as the extent to which advisors exhibit a high degree of
rationality in decision making are predictive of high-quality
financial advice.'' According to Bluethgen, et al., Financial Advice
and Individual Investors' Portfolios, Social Science Research
Network Abstract 968197 (Mar. 2008), ``advice enhances portfolio
diversification, makes investor portfolios more congruent with
predefined model portfolios, and increases investors' fees and
expenses. Our empirical evidence is broadly in line with honest
financial advice.''
---------------------------------------------------------------------------
Benefits
The Department expects the PPA and this proposed class exemption to
reduce investment errors to the benefit of participants. As noted
above, prior to implementation of the PPA, investment mistakes cost
participants $109 billion or more annually. Increased use of investment
advice under the PPA will reduce such mistakes by $7 billion, and this
proposed class exemption will reduce them by another $7 billion, the
Department estimates. Altogether after implementation of this proposed
class exemption, use of investment advice by DC plan and IRA
participants will eliminate $29 billion worth of investment errors
annually. The Department's estimates of investment errors and
reductions from investment advice are summarized in table 4.
4--Investment Errors and Impact of Advice ($Billions, Annual)
----------------------------------------------------------------------------------------------------------------
Errors eliminated by advice
Policy context Remaining -------------------------------
errors Incremental Cumulative
----------------------------------------------------------------------------------------------------------------
No advice....................................................... $124 $0 $0
Pre-PPA advice only............................................. 109 15 15
PPA............................................................. 102 7 22
Class exemption................................................. 95 7 29
----------------------------------------------------------------------------------------------------------------
Costs
Participant gains from investment advice must be weighed against
the cost of that advice. Different types of advice may come with
different costs. For example, advice generated by an automated computer
program may be less costly than advice provided by a personal adviser.
For purposes of this analysis the Department assumed that in the
context of a DC plan, computer generated advice costs 10 basis points
annually, while adviser provided advice costs 20 basis points. In
connection with an IRA the corresponding assumptions are 15 and 30
basis points. These assumptions are reasonable in light of information
available to the Department about the cost of various existing advice
arrangements. On this basis the Department estimates the cost of advice
as summarized in table 5.\64\
---------------------------------------------------------------------------
\64\ The Department notes that costs probably often will not be
distributed across advised participants in proportion to the size of
their accounts. Rather, it is likely that some costs of providing
advice are fixed relative to account size, so the cost borne by
small account holders probably will be larger in relation to account
size than that borne by large account holders. The average estimates
reported in table 4 are dollar weighted. For the average
participant, the basis point cost will be higher than this dollar
weighted average, and the amount by which investment errors are
reduced per dollar of advice will be lower.
5--Cost of Advice
----------------------------------------------------------------------------------------------------------------
Class
Pre-PPA PPA exemption
----------------------------------------------------------------------------------------------------------------
Incremental:
Advice cost ($billions)..................................... $3.8 $1.8 $2.3
Advice cost rate (bps, average)............................. 23 23 29
Error reduced per $1 of advice, average..................... $3.90 $3.80 $3.10
Cumulative (combined with policies to the left):
Advice cost ($billions)..................................... $3.8 $5.6 $7.9
Advice cost rate (bps, average)............................. 23 23 24
Error reduced per $1 of advice, average..................... $3.90 $3.90 $3.70
----------------------------------------------------------------------------------------------------------------
Alternatives
In formulating this proposed regulation and proposed class
exemption, the Department considered several alternative approaches.
Specific Substantive Standards for Model Certification
This proposed regulation provides mostly procedural standards for
the certification of computer models pursuant to PPA's statutory
exemptive relief. In crafting these provisions the Department carefully
considered whether to establish specific substantive standards as well.
Computer models are evolving, driven by advances in information
technology and financial theories, and by market competition. A recipe
for testing the robustness of one current technology might not be
effective when applied to a future technology. Ongoing refinements and
revisions to financial theories, the product of healthy competition
among ideas, would soon belie any specification of generally accepted
theory that might be enshrined in regulation. The Department therefore
believes that a substantive standard generally would not serve to
protect participants but instead might diminish the benefits of the
PPA's relief for arrangements using models. However, the Department
invites comments on the advantages and disadvantages of a more
substantive standard than what is proposed, and asks for suggestions
for what a more substantive standard might include.
Deferring Action on Class Exemption
The Department considered deferring proposing a class exemption for
a year or more in order to observe the market impact of the exemptive
relief provided by the PPA. This might have provided fuller information
on the degree to which some market segments would remain underserved by
advice and on the barriers responsible for such ongoing under service,
and thereby assisted the Department's effort to determine whether and
how to provide additional exemptive relief.
However, the Department is concerned that deferring action might
delay the proliferation of advice and prolong correctable investment
errors and believes that the need for additional exemptive relief is
already adequately
[[Page 49912]]
clear. The exemptive relief provided by the PPA does not embrace
business models that occupy large parts of the non-IRA retail
market,\65\ and therefore may leave major segments of the DC plan and
IRA markets underserved. In addition, by excluding popular business
models, the PPA's exemptive relief by itself would tilt the playing
field in favor of other business models, which may sometimes be more
expensive or less beneficial. This raises the possibility that some
segments of the market would be inefficiently served. This proposed
class exemption will level the playing field for competing business
models and thereby promote efficiency in the market for investment
advice.
---------------------------------------------------------------------------
\65\ See, e.g., Victoria Leonard-Chambers & Michael Bogdan, Why
Do Mutual Fund Investors Use Professional Financial Advisers?,
Investment Company Institute Research Fundamentals, Volume 16,
Number 1 (April 2007); and Employee Benefit Research Institute, 2007
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan.
2007).
---------------------------------------------------------------------------
Level Fee Condition
The PPA provides conditional exemptive relief for advice
arrangements wherein the revenue of a fiduciary adviser's affiliates
varies on the basis of advised participants' investment decisions, but
not to arrangements wherein the revenue of the fiduciary adviser itself
so varies. This proposed class exemption extends conditional relief to
the latter.
The Department considered including as a mandatory condition of
this proposed class exemption a requirement that the compensation
received by the person providing the advice on behalf of the fiduciary
adviser does not vary on the basis of participants' investment
decisions. Such a condition might ease enforcement of the exemption's
conditions, and might reduce the risks attendant to conflicts of
interest that may exist among advisers doing business pursuant to the
proposed class exemption. But it also would exclude from exemptive
relief popular business models that are well established in the non-IRA
retail market and that operate without similar compensation
requirements, and therefore might unduly impair the availability of
advice. Therefore Department elected to make this ``level fee''
condition \66\ one of two alternative conditions,\67\ thereby allowing
the person's compensation to vary as long as the other condition is
met. The other condition provides alternative protections against the
risks attendant to conflicts of interest.
---------------------------------------------------------------------------
\66\ See paragraph (f).
\67\ The alternative condition is at paragraph (e). Paragraph
(d) provides that the two are alternatives.
---------------------------------------------------------------------------
Model Generated Advice for IRA Beneficiaries
The Department considered including as part of the immediately
aforementioned alternative condition a requirement that IRA
beneficiaries always be provided with specific, model generated
investment recommendations, similar to those which under the condition
must be provided to DC plan participants.\68\ However the Department
believes that such a requirement sometimes might be neither practical
nor effective as applied to IRAs. It might not be practical because,
while such models exist, their availability, affordability and
effectiveness are not yet proven in all segments of the IRA market. It
might not be effective because the wide range of investment options
open to most IRA beneficiaries could make comparisons of model
generated advice with the advisers' recommendations difficult for
beneficiaries. Therefore the conditions of this proposed class
exemption allow that IRA beneficiaries may under certain circumstances
be provided with educational material or recommendations on asset
allocation across asset classes rather than with specific, model
generated investment recommendations.\69\
---------------------------------------------------------------------------
\68\ See paragraph (e)(1).
\69\ See paragraph (e)(2).
---------------------------------------------------------------------------
Uncertainty
The Department is highly confident in its conclusion that
investment errors are common and often large, producing large avoidable
losses (including foregone earnings) for participants. It is also
confident that participants can reduce errors substantially by
obtaining and following good advice. While the precise magnitude of the
errors and potential reductions therein are uncertain,\70\ there is
ample evidence that that magnitude is large.
---------------------------------------------------------------------------
\70\ The incidence and magnitude of investment errors is
uncertain. Because errors are generally measured with reference to
some optimal benchmark, the evolving character of investment theory
contributes to this uncertainty. For a given level of incidence and
effectiveness of advice, the reduction in errors will be
proportionate to the errors reduced. The Department did not attempt
to estimate the magnitude of losses from inappropriate risk or
excess taxes, so its estimate of this proposed class exemption's
impact omit potential reductions in such errors. As noted above, the
Department's estimate of higher than necessary expenses is
conservative in light of referenced literature and omits certain
less visible expenses such as mutual funds' internal transaction
costs. Its estimates of losses from poor trading strategies and
inadequate diversification are moderate, if not conservative, taking
account of the losses that were measured in the referenced studies.
The Department believes that the combined magnitude of investment
errors, and therefore of the reduction in such errors that can be
expected from wider use of advice, is at least as large as reported
here, and possibly much larger.
---------------------------------------------------------------------------
The Department is also confident that this proposed class
exemption, 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 proposed 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.
6--Uncertainty in Estimate of Investment Error Reduction
----------------------------------------------------------------------------------------------------------------
Impact of
Primary estimates denoted * Impact of PPA class Impact of all Remaining
exemption advice errors
----------------------------------------------------------------------------------------------------------------
Advice eliminates:
50% of errors *............................. $7 $7 $29 $95
75% of errors............................... 11 11 47 86
25% of errors............................... 3 3 14 102
After PPA/class exemption, advice reaches:
13%/16% of DC and 50%/67% of IRA *.......... 7 7 29 95
15%/21% of DC and 60%/80% of IRA............ 11 9 35 89
11%/13% of DC and 40%/50% of IRA............ 3 4 22 102
----------------------------------------------------------------------------------------------------------------
[[Page 49913]]
The Department is 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. As noted earlier, evidence on the efficiency of
existing menus is mixed.
The Department is uncertain about the mix of advice and other
support arrangements that will compose the market, and about the
relative effectiveness of alternative investment advice arrangements or
other means of supporting participants' investment decisions. For
example, to what extent will arrangements pursuant to this proposed
class exemption displace alternative arrangements? Will advice
arrangements operating pursuant to this proposed class exemption be
more, less, or equally effective as alternative arrangements?
This analysis has assumed that all types of advice arrangements are
equally effective at reducing investment errors, and that none will
increase errors (there will be no very bad advice). This assumption may
not hold, however, for a number of reasons. For example, as illustrated
above in table 1, advisers operating pursuant to different exemptive
relief may be subject to different levels of conflicts of interest.
Individuals providing advice pursuant to this proposed class exemption
may face particularly direct conflicts, in the form of opportunities to
tailor advice to directly profit themselves at participants' expense.
The Department's consideration of this risk was detailed above.
The conditions attached to exemptive relief under the PPA and this
proposed class exemption are intended to control this risk while
keeping advice affordable. The Department notes that if users of advice
are fully informed and rational then more cost effective arrangements
will dominate the market. This proposed class exemption establishes
conditions to ensure that prospective users of advice available
pursuant to it will have the opportunity to become fully informed.
The Department is uncertain about the potential magnitude of any
transitional costs associated with this proposed regulation and
proposed class exemption. These might include costs associated with
efforts of prospective fiduciary advisers to adapt their business
practices to the applicable conditions. They might also include
transaction costs associated with initial implementation of investment
recommendations by newly advised participants.
Another source of uncertainty involves potential indirect
downstream effects of this proposed regulation and proposed class
exemption. 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.
The Department invites comments on how to improve this analysis,
with particular attention to the assessment and explanation of
attendant uncertainty, and how such analysis could be carried out.
Comments that include specific suggestions or data to help support our
analysis of impacts and the characterization of uncertainty would be
especially useful.
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 proposed
regulation and proposed class exemption, 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
actions' impact. On that basis the Department believes that the
actions' benefits justify their costs.
Regulatory Flexibility Act
The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes
certain requirements with respect to Federal rules that are subject to
the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551 et seq.) and are likely to
have a significant economic impact on a substantial number of small
entities. For purposes of analysis under the RFA, the Department
proposes to continue its usual practice of considering a small entity
to be an employee benefit plan with fewer than 100 participants.\71\
The Department estimates that approximately 100,000 small plans, a
significant number, will voluntarily begin offering investment advice
to participants as a result of this proposed regulation and proposed
class exemption.
---------------------------------------------------------------------------
\71\ EBSA requests comments on the appropriateness of the size
standard used in evaluating the impact of these proposed rules on
small entities. EBSA has consulted with the SBA Office of Advocacy
concerning use of this participant count standard for RFA purposes.
See 13 CFR 121.903(c).
---------------------------------------------------------------------------
The primary effect of this proposed regulation and proposed class
exemption will be to reduce participants' investment errors. This is an
effect on participants rather than on plans. The impact on plans
generally will be limited to increasing the means by which they may
make advice available to participants, and this impact will be similar
and proportionate for small and large plans. Therefore the Department
certifies that the impact on small entities will not be significant.
Pursuant to this certification the Department has refrained from
preparing an Initial Regulatory Flexibility Analysis of this proposed
regulation and proposed class exemption. The Department invites the
public to comment on its definition of small entities and its
certification.
Notwithstanding this certification, the Department did separately
consider the impact of this proposed regulation and proposed class
exemption on participants in small plans.
As noted earlier, prior to implementation of the PPA smaller plan
sponsors offered advice generally, and in-person advice in particular,
more frequently than larger plan sponsors. The Department believes that
exemptive relief provided by both the PPA and this proposed class
exemption will promote wider offering of advice by small and large
plans sponsors alike. Accordingly the Department estimated the impacts
on small plans assuming that they generally will be proportionate to
those on large plans. However, because smaller plan sponsors are more
likely to offer in-person advice, their average cost for advice and the
proportion of participants using advice may both be higher. The
Department estimates that the PPA and this proposed class exemption
will reduce small DC plan participant investment errors
[[Page 49914]]
respectively by $105 million or more and $126 million or more, at
respective costs of $22 million and $28 million. The estimated impacts
on small plans and their participants are summarized on table 7.
7--Small DC Plan Participant Impacts
----------------------------------------------------------------------------------------------------------------
Class
Pre-PPA PPA exemption
----------------------------------------------------------------------------------------------------------------
Dollars advised ($ billions).................................... $47 $59 $73
Investment errors ($ billions).................................. $8.0 $7.9 $7.8
Incremental:
Errors reduced by advice ($ millions)....................... $421 $105 $126
Advice cost ($ millions).................................... $86 $22 $28
Advice cost rate (bps, average)............................. 18 18 20
Error reduced per $1 of advice, average..................... $4.88 $4.88 $4.46
Cumulative (combined with policies to the left):
Errors reduced by advice ($ millions)....................... $421 $526 $652
Advice cost ($ millions).................................... $86 $108 $136
Advice cost rate (bps, average)............................. 18 18 19
Error reduced per $1 of advice, average..................... $4.88 $4.88 $4.79
----------------------------------------------------------------------------------------------------------------
Congressional Review Act
This notice of proposed rulemaking 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, if finalized, will be
transmitted to the Congress and the Comptroller General for review.
Unfunded Mandates Reform Act
For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L.
104-4), as well as Executive Order 12875, the notice of proposed
rulemaking 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.
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 proposed 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 this proposed rule do not alter the
fundamental provisions of the statute with respect to employee benefit
plans, and as such would have no implications for the States or the
relationship or distribution of power between the national government
and the States.
Paperwork Reduction Act
As part of its continuing effort to reduce paperwork and respondent
burden, the Department of Labor conducts a preclearance consultation
program to provide the general public and Federal agencies with an
opportunity to comment on proposed and continuing collections of
information in accordance with the Paperwork Reduction Act of 1995
(PRA) (44 U.S.C. 3506(c)(2)(A)). This helps to ensure that the public
understands the Department's collection instructions; respondents can
provide the requested data in the desired format, reporting burden
(time and financial resources) is minimized, collection instruments are
clearly understood, and the Department can properly assess the impact
of collection requirements on respondents.
Currently, EBSA is soliciting comments concerning the proposed
information collection request (ICR) included in the Proposed Class
Exemption for the Provision of Investment Advice to Participants and
Beneficiaries of Self-Directed Individual Account Plans and IRAs and in
the Proposed Investment Advice Regulation (Proposed Investment Advice
Initiative). A copy of the ICR may be obtained by contacting the PRA
addressee shown below or at http://www.RegInfo.gov. PRA Addressee:
Gerald B. Lindrew, Office of Policy and Research, U.S. Department of
Labor, Employee Benefits Security Administration, 200 Constitution
Avenue, NW., Room N-5718, Washington, DC 20210. Telephone: (202) 693-
8410; Fax: (202) 219-5333. These are not toll-free numbers.
The Department has submitted a copy of the Proposed Investment
Advice Initiative to the Office of Management and Budget (OMB) in
accordance with 44 U.S.C. 3507(d) for review of its information
collections. The Department and OMB are particularly interested in
comments that:
Evaluate whether the collection of information is
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility;
Evaluate the accuracy of the agency's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
Enhance the quality, utility, and clarity of the
information to be collected; and
Minimize the burden of the collection of information on
those who are to respond, including through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology, e.g., permitting
electronic submission of responses.
Comments should be sent to the Office of Information and Regulatory
Affairs, Office of Management and Budget, Room 10235, New Executive
Office Building, Washington, DC 20503; Attention: Desk Officer for the
Employee Benefits Security Administration. OMB requests that comments
be received within 30 days of publication of the Proposed Investment
Advice Initiative to ensure their
[[Page 49915]]
consideration. Please note that comments submitted to OMB are a matter
of public record.
The Department notes that a federal agency cannot conduct or
sponsor a collection of information unless it is approved by OMB under
the PRA, and displays a currently valid OMB control number, and the
public is not required to respond to a collection of information unless
it displays a currently valid OMB control number. Also, notwithstanding
any other provisions of law, no person shall be subject to penalty for
failing to comply with a collection of information if the collection of
information does not display a currently valid OMB control number. EBSA
will publish a notice of OMB's action at the final rule stage.
In order to use the statutory exemption and/or the class exemption
\72\ to provide investment advice to participants and beneficiaries in
participant-directed defined contribution (DC) plans and beneficiaries
of individual retirement accounts (IRAs) (collectively hereafter,
``participants''), investment advisory firms would be required to make
disclosures to participants and hire an independent auditor every year.
Investment advice firms following the conditions of the exemption based
on disclosure of computer model-generated investments would be required
to obtain certification of the model from an eligible investment
expert.\73\ The class exemption conditions relief on establishing
written policies and procedures and both exemptions impose
recordkeeping requirements.\74\ These paperwork requirements are
designed to safeguard the interests of participants in connection with
investment advice covered by the exemptions.
---------------------------------------------------------------------------
\72\ The Department assumes that all advisory firms use both the
statutory exemption and the class exemption.
\73\ All costs associated with model certification are assigned
to the statutory exemption.
\74\ All costs associated with composing written policies and
procedures are assigned to the class exemption.
---------------------------------------------------------------------------
The Department has made several specific basic assumptions in order
to establish a reasonable estimate of the paperwork burden of this
information collection:
The Department assumes that 80% of disclosures \75\ will
be distributed electronically via means already in existence as a usual
and customary business practice and the costs arising from electronic
distribution will be negligible.\76\
---------------------------------------------------------------------------
\75\ This estimate is derived from Current Population Survey
October 2003 School Supplement probit equations applied to the
February 2005 Contingent Worker Supplement. These equations show
that approximately 81 percent of workers aged 19 to 65 had internet
access either at home or at work in 2005. The Department further
assumes that one percent of these participants will elect to receive
paper documents instead of electronic, thus 20 percent of
participants receive disclosures through paper media.
\76\ The Department assumes that plans will deliver disclosures
electronically in compliance with the Department's rules relating to
the use of electronic media (29 CFR 2520.104b-1(c)). The Department
has not estimated any additional burden for plans to receive
affirmative consents from participants to receive required
disclosures electronically. The Department welcomes comments on this
assumption.
---------------------------------------------------------------------------
The Department assumes that investment advisory firms will
use existing in-house resources to prepare the policies and procedures
and most disclosures and to maintain the recordkeeping systems. This
assumption does not apply to the computer model certification, the
audit or the computer program used to generate disclosures for IRA
participants.
The Department assumes a combination of personnel will
perform the information collections with an hourly wage rate for 2008
of $79 for a financial manager, $21 for clerical personnel, $109 for a
legal professional, and $67 for a computer programmer.\77\
---------------------------------------------------------------------------
\77\ Hourly wage estimates are based on data from the Bureau of
Labor Statistics Occupational Employment Survey (May 2005) and the
Bureau of Labor Statistics Employment Cost Index (Sept. 2006). All
hourly wage rates include wages and benefits. Clerical wage and
benefits estimates are based on metropolitan wage rates for
executive secretaries and administrative assistants. Financial
manager wage and benefits estimates are based on metropolitan wage
estimates for financial managers. Legal professional wage and
benefits estimates are based on metropolitan wage rates for lawyers.
Computer programmer wage and benefits estimates are based on
metropolitan wage rates for professional computer programmers.
---------------------------------------------------------------------------
The Statutory Exemption
The Department assumes that approximately 16,000 investment
advisory firms \78\ (including broker-dealers) will take advantage of
this statutory exemption to provide advice to participants.\79\ The
number of investment advisory firms using this statutory exemptive
relief is assumed to be constant over time. The Department estimates
that under the statutory exemption approximately 52,000 DC plans will
seek to provide advice to their participants and beneficiaries. These
DC plans represent approximately 6,611,000 participants and
beneficiaries, of which approximately 1,487,000 will seek advice from
the investment advisory firm servicing their employer-sponsored
retirement investment plan. IRAs can also make use of this statutory
exemption, and the Department estimates that approximately 8.7 million
IRA beneficiaries will seek advice under this statutory exemption.\80\
---------------------------------------------------------------------------
\78\ Unless otherwise noted, numbers are rounded to the nearest
1,000.
\79\ This estimate is derived from Angela A. Hung et al.,
Investor and Industry Perspectives on Investment Advisers and
Broker-Dealers, RAND Corporation Technical Report (2008), at http://
www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf.
\80\ To be conservative, the Department assumes that all 16,000
advisory firms give advice pursuant to both the statutory and class
exemptions as they all will have some clients who request only level
fee or computer model advice under the statutory exemption and other
clients who request off-model advice under the class exemption. The
Department estimates that there are approximately 209,000 DC plans
that are currently offering advice (pre-statutory exemption advice),
that after the statutory exemption is published approximately
261,000 DC plans will offer advice and that after the class
exemption is published approximately 314,000 DC plans will offer
advice. The Department cannot determine which of these plans will be
offering advice under pre-statutory exemption, statutory exemption
or class exemption conditions; thus the Department decided to apply
costs to the statutory and class exemptions based on the incremental
change in the number of DC plans offering advice. This method is
also applied to the number of IRA beneficiaries receiving advice;
the Department estimates that approximately 16.8 million IRA
beneficiaries received advice under pre-statutory exemption
conditions, approximately 25.5 million will receive advice under
statutory exemption conditions and approximately 34.0 will receive
advice under class exemption conditions. The Department welcomes
comments on this assumption.
---------------------------------------------------------------------------
Disclosures to Participants
In general, under section 2550.408(g)-1(g) of the proposal, a
fiduciary adviser is required to furnish detailed information to a
participant about an advice arrangement before initially providing
investment advice, annually, upon participant request and if there is
any material change to the information. The information includes the
following: The relationship between the adviser and the parties that
developed the investment advice program or selected the investment
options available under the DC plan or IRA; to the extent such
information is not otherwise provided, the past performance and
historical rates of return of investments available under the DC plan
or IRA; all fees and other compensation the fiduciary adviser or any
affiliate is to receive in connection with the provision of investment
advice or in connection with the investment; the fiduciary adviser's
material relationship, if any, to any investment under the arrangement;
the types of services the fiduciary adviser provides in connection with
the provision of investment advice; the manner in which participant
information may be used or disclosed; an acknowledgement that the
fiduciary adviser is acting as a fiduciary of the DC Plan or IRA in
connection with providing the investment advice; and notice that the
recipient of the advice may separately arrange for advice from
[[Page 49916]]
another adviser that could have no relationship to, and receive no fees
in connection with, the investments. If applicable, the fiduciary
adviser also furnishes in writing to the DC plan fiduciary an election,
as permitted under the regulation, to be treated as the sole fiduciary
providing investment advice through a computer model to an ERISA-
covered DC plan participant. The Department assumes that investment
advisory firms will compile all of these notices into a single four-
page disclosure package for each participant given advice. As these
disclosures are to be given to the participants and are based upon the
investments that are recommended, the Department further assumes that
these disclosures will be generated at three levels: The investment
advisory firm level, the DC plan level and the IRA beneficiary level.
The firms will generate a template for each of these disclosures
levels.\81\
---------------------------------------------------------------------------
\81\ The following disclosures are assumed to be constant for
all participants advised: The material affiliation or material
contractual relationships, use of participant information, type of
services provided by the fiduciary adviser, acknowledgment that the
adviser is acting as a fiduciary of the DC plan or IRA, and a
statement that the participant can arrange for advice from an
adviser who does not receive fees in connection with the investment
or has no material affiliation with the investments recommended. The
following disclosures are assumed to be constant for each
participant of an individual DC plan: The fees and compensation the
adviser receives in connection with the suggested investments and
the material affiliation to the suggested investments. As discussed
below these last two disclosures are also the only disclosures that
are specific to the IRA beneficiary, and as such will require the
adviser to generate individual disclosures for each IRA beneficiary
advised using the computer model generated by the service providers.
---------------------------------------------------------------------------
Preparation of Statutory Exemption Disclosure Package
For the first year (initial) disclosures, the Department assumes
that it takes a legal professional approximately six hours per
investment advisory firm to prepare disclosures that are common to all
of their participants, about 100 hours per investment advisory firm to
assist an out-sourced computer programmer in creating computer software
that will generate disclosure notices for IRA beneficiaries, and
approximately two and one-half hours per DC plan to prepare disclosures
that are common to all DC plan participants and beneficiaries in the
same DC plan. These hours add up to an hour burden of approximately
1,779,000 hours; at a wage rate of $109 for a legal professional the
equivalent cost is approximately $194,792,000.
For the annual updating of disclosures required by Section
2550.408g-1(g)(4)(ii), the Department assumes that the preparation time
needed for updating the notices that are the same for all participants
will be about three hours for each of the 16,000 investment advisory
firms.\82\ The Department assumes that updating notices that are the
same for all DC plan participants and beneficiaries is estimated to
take on average one hour and a half for each of over 52,000 DC plans.
The preparation time needed for individualized notices for IRAs is
estimated to average 50 hours for each of 16,000 investment advisory
firms. Thus the annual hour burden for preparation is estimated to be
approximately 903,000 hours with an equivalent cost of approximately
$98,829,000.
---------------------------------------------------------------------------
\82\ The Department assumes that investment advisory firms will
distribute the same disclosures throughout the year and that they
only update their disclosure content for the annual disclosures. The
Department further assumes that few disclosures are requested each
year (one per firm on average) and most requested disclosures are
distributed either electronically at a negligible cost or in person
at small costs. The Department welcomes comments on these
assumptions.
---------------------------------------------------------------------------
The Department assumes that all firms will outsource the creation
of a computer program to enable them to prepare disclosures for IRA
participants. This computer model will be used to generate disclosures
to participants under both the statutory exemption and the class
exemption. The Department estimates that a computer programmer will
charge on average $1,200 per firm in the first year and $600 each
subsequent year.\83\ Thus the cost burden, given there are almost
16,000 investment advisory firms, will be approximately $18,662,000 in
the first year and approximately $9,331,000 in all subsequent years.
---------------------------------------------------------------------------
\83\ The Department has based this cost estimate on limited
industry data.
---------------------------------------------------------------------------
Distribution of Statutory Exemption Disclosure Package
The Department assumes that a clerical professional will be
required to spend one minute per page (four minutes per disclosure
package) to photocopy the 20 percent of disclosure packages that are
delivered in paper and one minute per disclosure package to prepare the
ten percent of disclosures that are mailed each year.\84\ These hours
add up to an hour burden of approximately 864,000 hours; at a wage rate
of approximately $21 for a clerical professional the equivalent cost is
approximately $3,225,000.
---------------------------------------------------------------------------
\84\ Eighty percent of disclosures are assumed to be distributed
electronically. In addition, the Department assumes that one half of
all paper disclosures are delivered in person and one half are
delivered through the mail.
---------------------------------------------------------------------------
The Department assumes that the paper and photocopy costs are five
cents per page; thus, given that there are approximately 2,030,000
participants receiving paper disclosures, the associated cost burden
for paper and photocopying under the statutory exemption is estimated
to be $406,000 annually. Under the basic United States Postal Service
postage at a cost of $0.42 \85\ per disclosure package for
approximately 1,015,000 participants receiving mailed disclosures, the
postage costs are estimated at about $426,000 annually. Thus the cost
burden associated with distributing disclosures to participants is
$832,000 per year.
---------------------------------------------------------------------------
\85\ The USPS increased the cost of First Class Postage to $0.42
as of May 2008.
---------------------------------------------------------------------------
Independent Certification
If the fiduciary adviser provides the investment advice through use
of a computer model, then before providing the advice, Section
2550.408g-1(d)(2) of the proposed regulation would require the
fiduciary adviser to obtain the certification of an eligible investment
expert as to the computer model's compliance with certain standards
(e.g., applies generally accepted investment theories, unbiased
operation, objective criteria) set forth in the regulation. The
Department assumes that there are six companies that will provide the
investment advice computer model \86\ and that legal professionals
working at these six companies supply in-house support by providing
documentation and other information to the eligible investment expert
who certifies the company's investment advice computer model. These
legal professionals are assumed to spend about 40 hours for each of the
six investment advice computer model providers and on average 40 hours
for each of the almost 16,000 investment advisory firms to whom the
computer model providers supply their models. Thus, the investment
advice computer model providers have an hour burden of approximately
622,000 hours for an equivalent cost of about $68,125,000.
---------------------------------------------------------------------------
\86\ Based on limited information with respect to the investment
computer model industry, the Department estimates that there are six
companies that produce investment advice computer models.
---------------------------------------------------------------------------
The Department assumes that the investment advisory firm will need
in-house legal professionals to provide documentation and other
information to the eligible investment expert who certifies the
investment advisory firm's investment advice computer model. These
legal professionals will spend on average ten hours for each of over
52,000 DC plans and on average 50
[[Page 49917]]
hours for each of the almost 16,000 investment advisory firms. Thus the
hour burden in the first year for the certification of the investment
advice computer model is approximately 1,924,000 hours with an
equivalent cost of about $210,571,000.
The Department assumes that in subsequent years the hours required
for any investment advice computer model recertification will be
approximately half of the first certification and that investment
advisory firms will have their investment advice computer model
recertified on average once a year. Thus in the subsequent years the
hour burden is approximately 962,000 hours with an equivalent cost of
approximately $105,286,000.
Recordkeeping Requirements
Consistent with the statutory exemption, section 2550.408g-1(i) of
the proposed regulation would require fiduciary advisers to maintain
records with respect to the investment advice provided in reliance on
the regulation necessary to determine whether the applicable
requirements of the regulation have been satisfied. The Department
assumes that all investment advisory firms maintain recordkeeping
systems as part of their normal business practices. The Department
assumes that all records that are required to be maintained will be
kept electronically under normal business practices; therefore, no
printing and negligible holding costs are anticipated to be associated
with records maintenance.
Audit Requirement
Any fiduciary adviser relying on the exemption would be required to
engage, at least annually, an independent auditor to conduct an audit
of the investment advice arrangement for compliance with the conditions
of the exemption pursuant to section 2550.408g-1(f)(1) of the proposed
regulation. All firms are assumed to outsource this service but use
some internal clerical and legal professional time to assist the
auditor. \87\ The clerical staff is expected to spend about three hours
per advisory firm and on average ten minutes per participant to gather
documentation and other information. The in-house legal professional is
expected to need approximately four hours per advisory firm to assist
the auditor with the statutory exemption audit. The Department
estimates that about one percent of participants will be audited per
year, resulting in approximately 101,000 audits. Overall, the annual
in-house hour burden for the annual audit requirement is estimated at
126,000 hours, with equivalent costs of approximately $8,157,000.
---------------------------------------------------------------------------
\87\ Audit firms are expected to transmit the final audit report
to the advisory firm through electronic means at no additional
costs. The advisory firms must either furnish a copy of the audit
report to IRA beneficiaries or make the audit report available on
their Web site and inform IRA beneficiaries of the purpose of the
report and how and where to locate the report applicable to their
account with the other disclosures discussed above. The Department
assumes that all advisory firms will make the audit report available
on their Web site and add a few sentences to the single disclosure
package at negligible costs. Any advisory firm whose audit report
identifies noncompliance with the requirements of the statutory or
class exemption must send a copy of the report to the Department
within 30 days following receipt of the report. The Department
assumes that the majority of advisory firms will comply with the
exemption; therefore, the costs associated with sending the audit
reports to the Department are expected to be negligible. The
Department welcomes comments on this assumption.
---------------------------------------------------------------------------
The Department assumes that the statutory exemption audits will be
outsourced to an independent legal professional for each of the almost
16,000 investment advisory firms and will cost on average $18,000.\88\
Thus the annual cost burden will be approximately $279,936,000.
---------------------------------------------------------------------------
\88\ The Department has based this cost estimate on limited
industry data.
---------------------------------------------------------------------------
Summary of Statutory Exemption Hour and Cost Burden
In summary, the third-party disclosures, computer model
certification, and audit requirements for the statutory exemption
require approximately 3,981,000 burden hours with an equivalent cost of
approximately $416,745,000 and a cost burden of approximately
$579,367,000 in the first year. In each subsequent year the total labor
burden hours are estimated to be approximately 2,143,000 hours with an
equivalent cost of approximately $215,497,000 and the cost burden is
estimated at approximately $430,067,000 per year.
The Class Exemption
The Department assumes that all of the 16,000 investment advisory
firms that take advantage of the statutory exemption will also provide
advice that relies on the class exemption. As mentioned above, all
investment advisory firms provide advice under both DC plans and IRAs,
and the number of investment advisory firms using this class exemptive
relief is assumed to be constant over time. The Department estimates
that under the class exemption approximately 52,000 DC retirement plans
will seek to provide advice to their participants and beneficiaries.
These plans represent approximately 6,611,000 participants and
beneficiaries, of which approximately 2,016,000 will seek advice from
the investment advisory firm employed on behalf of their employer
sponsored retirement investment plan. IRAs can also make use of this
class exemption, and the Department estimates that approximately 8.5
million IRA beneficiaries will seek advice under this class
exemption.\89\
---------------------------------------------------------------------------
\89\ See footnote 51 above for an explanation of the number of
entities affected by the regulation. The Department assumes that
these DC plans are offering, and DC participants and beneficiaries,
and IRA beneficiaries are receiving advice under the class exemption
but not the statutory exemption.
---------------------------------------------------------------------------
Disclosures to Participants
In general, section III(g)(1) of the Class Exemption requires a
fiduciary adviser to furnish detailed information to a participant
about an advice arrangement before initially providing investment
advice, annually, upon participant request, and if there is any
material change to the information. The information to be provided is
the same under the class exemption as the statutory exemption (see
Section I(a) above for a listing of all required disclosures).
Additional disclosures required before providing investment advice
would depend on which alternative conditions the arrangement is
designed to satisfy. If the investment advice arrangement is based on
the disclosure of computer-generated investment selections, the
fiduciary adviser is required to furnish those selections to the
participant. If the fiduciary adviser determines computer modeling of
the number and types of investment choices available to an IRA is
reasonably precluded, the fiduciary adviser may instead furnish asset
class allocation models to the participant. Alternatively, such
disclosures may not be required if a fiduciary adviser satisfies the
condition that would require that the compensation of the person
providing advice on behalf of the fiduciary adviser may not vary based
on the particular investments selected. The Department assumes that
investment advisory firms will compile all notices into a single five-
page disclosure package for each participant given advice under the
class exemption and that these disclosures will be prepared at the
investment advisory firm, DC plan, and IRA beneficiary levels.
Preparation of Class Exemption Disclosure Package
The Department assumes that disclosures that are common to all of
the advisory firm's client participants as well as the computer program
used to
[[Page 49918]]
generate disclosures to IRA beneficiaries will have been prepared to
conform to the requirements of the statutory exemption and will not
impose any additional burden on respondents.
For the first year disclosures, the Department assumes that the
16,000 investment advisory firms might require a legal professional to
work on average 80 hours each to assist an out-sourced computer
programmer in creating computer software that will generate
individualized disclosure notices for IRA participants, and
approximately two hours per DC plan to prepare disclosures that are
common to all participants in the same DC plan. These hours add up to
an hour burden of approximately 1,349,000 hours; at a wage rate of $109
for a legal professional the equivalent cost is approximately
$147,662,000.
For the annual updating of disclosures the Department assumes that
the preparation time needed for updating the notices will be on average
one hour per DC plan (for DC plan individualized disclosures) and on
average 40 hours for each investment advisory firms (for IRA
beneficiary individualized disclosures). Thus, the annual hour burden
is estimated to be approximately 674,000 with an equivalent cost of
approximately $73,831,000.
Distribution of Class Exemption Disclosure Package
The Department assumes that a clerical professional will spend five
minutes \90\ to photocopy each of the approximately 2,102,000
disclosure packages that are delivered in paper and one minute to
prepare each of the 1,051,000 disclosures that are mailed each year.
These hours add up to an hour burden of approximately 193,000 hours; at
a wage rate of $21 for a clerical professional the equivalent cost is
approximately $4,082,000.
---------------------------------------------------------------------------
\90\ The Department estimates that most of the investment
advisory firms that take advantage of the class exemption will
determine that computer modeling of the number and types of
investment choices available to an IRA is not possible, and will
instead furnish asset class allocation models to the beneficiaries.
As such, the disclosure package for participants who receive advice
pursuant to the class exemption is estimated as being five pages in
length, instead of four.
---------------------------------------------------------------------------
Using a paper and photocopy cost of five cents per page, the
associated cost burden for paper and photocopying under the class
exemption is estimated to be $525,000 annually. Under the basic USPS
postage at a cost of $0.42 per disclosure package, the cost burden of
the mailing disclosures under the class exemption will be approximately
$441,000 annually. Thus the overall cost burden associated with
distributing disclosures to participants is estimated at about $967,000
per year.
Independent Certification
The entire costs of the certification requirements are accounted
for under the statutory exemption.
Policies and Procedures
Section III(i) of the Class Exemption requires investment advisory
firms that wish to provide investment advice pursuant to the class
exemption to develop written policies and procedures that insure the
firm follows all of the class exemption requirements. The Department
estimates that updating the written policies and procedures will
generally require no additional costs. It is assumed that the
preparation of these policies and procedures will require on average
seven hours of legal professional time for each of the almost 16,000
investment advisory firms. This leads to an hour burden in the first
year of about 109,000 hours with an equivalent cost of approximately
$11,917,000.
Recordkeeping Requirements
Section III(n) of the proposed class exemption requires fiduciary
advisers to maintain records with respect to the investment advice
provided in reliance on the exemption necessary to determine, explain
or verify compliance with the conditions of the exemption, including
those records necessary to determine that the disclosures described
above have been made. In this connection, the fiduciary adviser would
be required to maintain records necessary to determine, among other
things, that an independent fiduciary has provided express
authorization of the arrangement under which the investment advice is
provided, that, if applicable, an eligible investment expert has
provided the requisite certification, that the compensation to the
fiduciary adviser and its affiliates in connection with the investments
is reasonable, that the terms of the purchase sale or holding of the
investment are at least as favorable to the plan or IRA as those in an
arm's length transactions would be, and in cases where the advice is
not provided after disclosure of computer generated investments or an
asset class allocation model, the fees or other compensation received
by an employee, agent or registered representative providing investment
advice on behalf of the fiduciary adviser does not vary depending on
the option. The Department assumes that all investment advisory firms
maintain recordkeeping systems to satisfy these information collections
requirements.
A fiduciary adviser may provide individualized investment advice to
participants or beneficiaries (``off-model advice'') following the
furnishing of investment advice generated by a computer model as
described in section III(e)(1) of the Class Exemption, or in the case
of beneficiaries of IRAs described in section III(e)(2), following the
furnishing of investment education-type materials (graphs, pie charts,
etc) that produce or reflect asset allocation models. However, section
III(e)(4) of the Class Exemption requires that, with respect to any
off-model advice that recommends investment options that may generate
for the adviser or certain other parties greater income than other
investments in the same asset class, the individual who provides
investment advice on behalf of the fiduciary adviser, not later than 30
days after providing the advice, must document the basis for concluding
that the recommendation is in the best interest of the participant or
beneficiary. The Department assumes that such off -model advice will be
provided in ten percent of the possible DC plan cases, and 30 percent
of the possible IRA beneficiary cases. Thus, of the approximately
2,016,000 DC participants and approximately 8.5 million IRA
beneficiaries receiving advice under the class exemption, almost
202,000 DC plan participants and 2.5 million IRA beneficiaries will
receive off-model advice.\91\
---------------------------------------------------------------------------
\91\ Based on limited information on the type of advice given to
participants, the Department estimates that ten percent of DC plan
participants and 30 percent of IRA beneficiaries will receive off-
Model Advice.
---------------------------------------------------------------------------
The Department further assumes that each participant receiving
advice will receive this advice an average of four times per year (once
a quarter), resulting in almost 10,996,000 reports. The Department
assumes that each investment advisor who provides off-model advice will
need approximately 15 minutes to write this report. Generating these
reports is estimated to result in approximately 2,749,000 annual burden
hours for the financial manager with an associated equivalent cost of
$217,125,000.
Audit
Any fiduciary adviser relying on the class exemption also would be
required to engage, at least annually, an independent auditor to
conduct an audit of the investment advice arrangement for compliance
with the class exemption and written policies and procedures (as
described below) designed to assure
[[Page 49919]]
compliance with the conditions of the exemption. The fiduciary adviser
would be required to issue a written report to each plan fiduciary who
authorized the use of the investment advice arrangement, and to IRA
beneficiaries, setting forth the auditor's findings. With respect to
IRA's, the fiduciary adviser may instead make the report available on
its Web site. Also with respect to an arrangement with an IRA, if the
auditor finds noncompliance with the exemption, the fiduciary adviser
must file the report with the Department of Labor.
All firms are assumed to outsource this service but use some
internal clerical and legal professional time to assist the auditor. As
an audit is required under the statutory exemption, the fixed in-house
hours are attributed to the statutory exemption and only the variable
clerical hours are divided between the statutory and class exemption.
Under the class exemption clerical staff is expected to spend on
average ten minutes per audited participant to pull each audited
participant's files or to provide other documentation or information.
The Department estimates that about 105,000 participants will be
audited annually. Overall, the annual in-house hour burden for the
audit requirement is estimated at 18,000 hours with equivalent costs of
approximately $371,000.
The Department assumes that the class exemption audits will be
outsourced to an independent legal professional for each of the almost
16,000 investment advisory firms and will cost on average $4,000 per
year for each investment advisory firm.\92\ Thus the annual cost burden
will be approximately $62,208,000.
---------------------------------------------------------------------------
\92\ The Department has based this cost estimate on limited
industry data.
---------------------------------------------------------------------------
Summary of Class Exemption Hour and Cost Burden
In summary, the third-party disclosures, written policies and
procedures, recordkeeping and audit requirements for the class
exemption are estimated to require a total of approximately 4,417,000
burden hours with an equivalent cost of approximately $381,157,000 and
a total cost burden of approximately $63,175,000 in the first year. In
each subsequent year the total burden hours are estimated at
approximately 3,634,000 hours with an equivalent cost of approximately
$295,409,000 and a total cost burden of approximately $63,175,000 per
year.
Overall Exemption Hour and Cost Burden Summary
In summary, the third-party disclosures, computer model
certification, written policies and procedures, recordkeeping and audit
requirements for the statutory and class exemptions require
approximately 8,398,000 burden hours with an equivalent cost of
approximately $797,903,000 and a cost burden of approximately
$642,541,000 in the first year. The labor burden hours in each
subsequent year are approximately 5,776,000 hours with an equivalent
cost of approximately $510,906,000 and the cost burden in each
subsequent year is approximately $493,242,000 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: 20,656,000.
Frequency of Response: Initially, Annually, Upon Request, when a
material change.
Estimated Total Annual Burden Hours: 8,398,000 hours in the first
year; 5,776,000 hours in each subsequent year.
Estimated Total Annual Burden Cost: $642,541,000 for the first
year; $493,242,000 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.
For the reasons set forth in the preamble, the Department proposes
to amend 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
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. Sec. 2550.404c-1 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. 2550.412-1 also issued under
29 U.S.C. 1112.
2. Add Sec. 2550.408g-1 to read as follows:
Sec. 2550.408g-1 Investment Advice--Participants and Beneficiaries.
(a) General. Section 408(g)(1) of the Employee Retirement Income
Security Act, as amended (ERISA), provides 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.'' Section 4975(d)(17) and (f)(8) of the
Internal Revenue Code, as amended (the Code), contain parallel
provisions to ERISA section 408(b)(14) and (g)(1).
(b) Eligible investment advice arrangement. 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 (c) of this section or paragraph (d) of
this section, or both.
(c) Arrangements that use fee-leveling. For purposes of this
section, an arrangement is an eligible investment advice arrangement
if--
(1)(i) 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
[[Page 49920]]
that take into account additional considerations;
(ii) Any investment advice takes into account information furnished
by a participant or beneficiary relating to age, life expectancy,
retirement age, risk tolerance, other assets or sources of income, and
investment preferences, although nothing herein shall preclude any
investment advice from taking into account additional information that
a participant or beneficiary may provide;
(iii) 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;
(iv) 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
(2) The requirements of paragraphs (e), (f), (g), (h), and (i) of
this section are met.
(d) 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 (d)(1)
and (2) of this section under an investment advice program and with
respect to which the requirements of paragraphs (e), (f), (g), (h), and
(i) are met, and any acquisition, holding or sale of a security or
other property pursuant to such advice occurs solely at the direction
of the participant or beneficiary.
(1) A computer model shall be designed and operated to--
(i) 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;
(ii) Utilize information furnished by a participant or beneficiary
relating to age, life expectancy, retirement age, risk tolerance, other
assets or sources of income, and investment preferences, although
nothing herein shall preclude a computer model from taking into account
additional information that a plan or a participant or beneficiary may
provide;
(iii) Utilize appropriate objective criteria to provide asset
allocation portfolios comprised of investment options available under
the plan;
(iv) Avoid investment recommendations that:
(A) 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
(B) 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;
(v) Take into account all designated investment options, within the
meaning of paragraph (j)(1) of this section, available under the plan
without giving inappropriate weight to any investment option; except
that a computer model shall not be treated as failing to meet this
requirement merely because it does not take into account an investment
option that constitutes an investment primarily in qualifying employer
securities.
(2) Prior to utilization of the computer model, the fiduciary
adviser shall obtain a written certification, meeting the requirements
of paragraph (d)(4) of this section from an eligible investment expert,
within the meaning of paragraph (d)(3) of this section, that the
computer model meets the requirements of paragraph (d)(1) of this
section. If, following a certification, a computer model is modified in
a manner that may affect its ability to meet the requirements of
paragraph (d)(1), the fiduciary adviser shall, prior to utilization of
the modified model, obtain a new certification from an eligible
investment expert that the computer model, as modified, meets the
requirements of paragraph (d)(1).
(3) 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 (d)(4) of this section, whether a
computer model meets the requirements of paragraph (d)(1) 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.
(4) A certification by an eligible investment expert shall--
(i) Be in writing;
(ii) Contain--
(A) An identification of the methodology or methodologies applied
in determining whether the computer model meets the requirements of
paragraph (d)(1) of this section;
(B) An explanation of how the applied methodology or methodologies
demonstrated that the computer model met the requirements of paragraph
(d)(1) of this section;
(C) 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 (d)(1) of this section;
(D) 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 (d)(1);
(E) A statement certifying that the eligible investment expert has
determined that the computer model meets the requirements of paragraph
(d)(1) of this section; and
(iii) Be signed by the eligible investment expert.
(5) The selection of an eligible investment expert as required by
this section is a fiduciary act governed by section 404(a)(1) of ERISA.
(e) Arrangement must be authorized by a plan fiduciary. 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.
(f) Annual audit. (1) The fiduciary adviser shall, at least
annually, engage an independent auditor, who has appropriate technical
training or experience and proficiency, and so
[[Page 49921]]
represents in writing to the fiduciary adviser, to:
(i) Conduct an audit of the investment advice arrangements for
compliance with the requirements of this section; and
(ii) 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, consistent with paragraph (e) of
this section, setting forth the specific findings of the auditor
regarding compliance of the arrangement with the requirements of this
section.
(2) With respect to an arrangement with an IRA, the fiduciary
adviser:
(i) Within 30 days following receipt of the report from the
auditor, as described in paragraph (f)(1)(ii) of this section, shall
furnish a copy of the report to the IRA beneficiary or make such report
available on its website, provided that such beneficiaries are provided
information, with the information required to be disclosed pursuant to
paragraph (g) of this section, concerning the purpose of the report,
and how and where to locate the report applicable to their account; and
(ii) 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.
(3) For purposes of this paragraph (f), 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.
(4) For purposes of this paragraph (f), 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.
(g) Disclosure. (1) 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--
(i) Of 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;
(ii) Of 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;
(iii) Of 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;
(iv) Of any material affiliation or material contractual
relationship of the fiduciary adviser or affiliates thereof in the
security or other property;
(v) Of the manner, and under what circumstances, any participant or
beneficiary information provided under the arrangement will be used or
disclosed;
(vi) Of 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) of this section, any limitations on the
ability of a computer model to take into account an investment option
that constitutes an investment primarily in qualifying employer
securities, as provided for in paragraph (d)(1)(v) of this section;
(vii) That the adviser is acting as a fiduciary of the plan in
connection with the provision of the advice; and
(viii) 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.
(2)(i) The notification required under paragraph (g)(1) 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.
(ii) The appendix to this section contains a model disclosure form
that may be used to provide notification of the information described
in paragraph (g)(1)(iii) 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 requirement of paragraphs (g)(1) and
(2)(i) of this section with respect to such information.
(3) The notification required under paragraph (g)(1) of this
section may, in accordance with 29 CFR 2520.104b-1, be provided in
written or electronic form.
(4) At all times during the provision of advisory services to the
participant or beneficiary pursuant to the arrangement, the fiduciary
adviser must--
(i) Maintain the information described in paragraph (g)(1) of this
section in accurate form and in the manner described in paragraph
(g)(2) of this section,
(ii) Provide, without charge, accurate information to the recipient
of the advice no less frequently than annually,
(iii) Provide, without charge, accurate information to the
recipient of the advice upon request of the recipient, and
(iv) Provide, without charge, accurate information to the recipient
of the advice concerning any material change to the information
required to be provided to the recipient of the advice at a time
reasonably contemporaneous to the change in information.
(h) Other Conditions. The requirements of this paragraph are met
if--
(1) 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,
(2) The sale, acquisition, or holding occurs solely at the
direction of the recipient of the advice,
(3) 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
(4) 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.
(i) Maintenance of Records.--The fiduciary adviser must maintain,
for a period of not less than 6 years after the provision of investment
advice pursuant to the arrangement, any records necessary for
determining whether the
[[Page 49922]]
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.
(j) 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) 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--
(i) 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,
(ii) 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,
(iii) An insurance company qualified to do business under the laws
of a State,
(iv) A person registered as a broker or dealer under the Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.),
(v) An affiliate of a person described in any of clauses (i)
through (iv), or
(vi) An employee, agent, or registered representative of a person
described in paragraphs (j)(2)(i) through (v) of this section who
satisfies the requirements of applicable insurance, banking, and
securities laws relating to the provision of advice.
(vii) 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 (d) 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 (j)(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 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;
(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 (j)(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 written
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.
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 Advisor 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]
has a material affiliation or material contractual relationship
\93\) 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.]
---------------------------------------------------------------------------
\93\ See 29 CFR 2550.408g-1.
---------------------------------------------------------------------------
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
[[Page 49923]]
concerning the fees and other charges of each investment fund is
available from [enter source, such as: Your plan administrator,
investment fund provider (possibly with Internet Web site address)].
This information should be reviewed carefully before you make an
investment decision.
(if applicable enter, [enter name of Fiduciary Adviser] or
affiliates of [enter name of Fiduciary Adviser] also receive
compensation from non-affiliated investment funds as a result of
investments you make as a result of recommendations of [enter name
of Fiduciary Adviser]. The amount of this compensation also may vary
depending on the particular fund in which you invest. This
compensation may range from --% to --%. Specific information
concerning the fees and other charges of each investment fund is
available from [enter source, such as: Your plan administrator,
investment fund provider (possibly with Internet Web site address)].
This information should be reviewed carefully before you make an
investment decision.
(if applicable enter, In addition to the above, [enter name of
Fiduciary Adviser] or affiliates of [enter name of Fiduciary
Adviser] also receive other fees or compensation, such as
commissions, in connection with the sale, acquisition of 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.
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.
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 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.
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].
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 section 408(b)(14) and (g). Section
4975(f)(8) of the Internal Revenue Code, as amended (the Code),
contains a parallel provision to ERISA section 408(g)(11). 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(j)(2) (i) through
(v),
(B) Develops the computer model, or markets the computer model or
investment advice program, utilized in satisfaction of 29 CFR
2550.408g-1(d) 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(e); and
(v) Is maintained in accordance with 29 CFR 2550.408g-1(i).
Signed at Washington, DC, this 15th day of August, 2008.
Bradford P. Campbell,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. E8-19272 Filed 8-21-08; 8:45 am]
BILLING CODE 4510-29-P