- DOL Proposes Guidance on Investment Advice Exemption for Individual Account Plans and IRAs
- October 2, 2008 | Authors: Carly Grey; Larry R. Goldstein
- Law Firms: McGuireWoods LLP - Washington Office ; McGuireWoods LLP - Chicago Office
Millions of participants in individual account retirement plans (including 401(k) and profit-sharing plans) are able to direct the investments of their accounts. Congress recognized that many of these persons might benefit from professional investment advice. Thus, when it enacted the Pension Protection Act of 2006 (the “PPA”), it included amendments to the Internal Revenue Code (the “Code”) and the Employee Retirement Income Security Act of 1974 (“ERISA”) to provide an exemption to the prohibited transaction rules and excise taxes for advice provided under “eligible investment advice arrangements” in individual account plans and individual retirement accounts (“IRAs”).
Under the PPA amendment, subject to various additional requirements, there is an “eligible investment advice arrangement” where:
- Any fees (including any commissions) received by the “fiduciary adviser” for investment advice or as 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; or
- The fiduciary adviser uses a computer model under an investment advice program in connection with providing investment advice.
Last month, the Department of Labor (the “DOL”) issued complex proposed regulations to provide details on how to meet the requirements for eligible advice arrangements. The DOL also proposed a lengthy prohibited transaction exemption that would provide additional relief in certain areas.
The proposed regulations define a “fiduciary adviser” to a plan as a person who is a fiduciary of the plan by reason of the provision of investment advice to a participant of the plan or IRA and who is one of the following:
- A registered investment adviser;
- A bank or savings association;
- An insurance company;
- A registered broker or dealer;
- An affiliate of any of the above;
- An employee, agent, or registered representative of a person described above who satisfies the requirements of applicable insurance, banking and securities laws relating to the provision of advice; and
- With certain exceptions, any person who develops the computer model, or markets the computer model or investment advice program, under a computer-model eligible investment advice arrangement.
Under the proposed regulations, compensation for the purposes of the level-fee requirement may be received indirectly by a fiduciary adviser through an employee, agent or registered representative of the fiduciary adviser. However, this does not extend to the fiduciary adviser’s affiliates. In addition, incentive compensation based on a fiduciary adviser’s overall success, as opposed to the participant’s selection of an investment option, does not violate the level-fee requirement.
In contrast to the fee-leveling requirement under the PPA amendment to ERISA and the Code and the proposed regulations, under the proposed class exemption, the fee-leveling requirement would apply only to the individual who provides investment advice. The DOL was persuaded that the safeguards provided for in the class exemption would be sufficient to permit the application of the fee-leveling requirement at the individual-level, rather than fiduciary adviser-entity level, without compromising the availability of informed, unbiased and objective investment advice for plan participants and IRA beneficiaries.
To satisfy the computer-model arrangement requirements, the proposed regulations require that advice be given pursuant to a computer model that considers all designated investment options available under a plan, taking into account objective criteria and not inappropriately favoring options that may benefit the fiduciary adviser or a person having a material relationship with the fiduciary adviser. A material relationship exists with any of the following:
- 5% control persons; and
- Parties to an agreement that provides for payment to one person of greater than 10% of that person’s gross revenue on an annual basis by the other person.
Prior to use or modification of a computer model, the fiduciary adviser must get written certification from an eligible investment expert that the model meets the criteria of the proposed rule. The eligible investment expert may not have a material relationship with the investment adviser.
In addition, there would be prohibited-transaction relief under the proposed exemption for individualized investment advice to persons following the furnishing of recommendations generated by a computer model or, in the case of IRAs for which modeling is not feasible, the furnishing of certain investment education material. The “off-model” advice may not recommend options that would violate the level fee requirement unless the fiduciary adviser determines that it is in the best interests of the plan participant or IRA beneficiary and discloses the conflict to him or her. Such off-model advice must then be documented within 30 days.
To meet either the level-fee or computer model requirements, the proposed regulations require that investment advice be based on generally-accepted investment theories that consider historic returns and information furnished by the participant relating to age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and investment preferences.
Authorization and Audit
Under the proposed regulations, an eligible investment advice arrangement must be expressly authorized in advance by a plan fiduciary or IRA beneficiary other than the person providing the advice or an affiliate thereof.
Additionally, a fiduciary adviser must obtain an annual independent audit that results in a written report within 60 days of the audit. The fiduciary adviser must, within 30 days of receipt, furnish the report to or post the report on its website for IRA beneficiaries. If noncompliance is found and the exemption is being relied on for IRAs, then the report must also be submitted to the DOL.
Disclosure and Recordkeeping
The proposed regulations further provide that prior to giving advice under the investment advice exemption, and at least annually thereafter, the fiduciary adviser must give participants written or electronic notice of the following:
- The role of any party with a material relationship with the fiduciary adviser in the development of the advice program and the selection of investment options available under the plan;
- Past performance and historical rates of return of designated investment options, if not otherwise provided;
- All fees or other compensation (including any from third parties) to be received by the fiduciary adviser or an affiliate in connection with the advice or investment activity;
- Any material relationship of the fiduciary adviser or affiliates in the security or other property;
- The manner and circumstances in which participant information provided under the arrangement will be used;
- The types of services provided by the fiduciary adviser in connection with the investment advice, including any limitations on the ability of a computer model to consider options primarily invested in employer securities;
- The fact that the adviser is acting as a fiduciary to the plan in providing the advice;
- The fact that the recipient of the advice may separately arrange for advice from another adviser that may not have a material affiliation with, or receive fees or compensation in connection with, the security or property; and
- The purpose of the audit report and how and where to locate it (if the exemption is being relied upon for IRAs).
A model form provided by the DOL may be used to meet this disclosure requirement.
The proposed regulations also require that records necessary to determine whether the applicable requirements of the regulation have been met must be kept for six years following the provision of advice.