The Final Investment Advice Regulations
By William C. Grossman, ERPA, QPA, APR, Director of Education and Communications, McKay Hochman Co., Inc.
Editor’s note: I thought Bill Grossman did a great job succinctly summarizing the final investment advice regulations. This article appears courtesy of McKay Hochman.
The U.S. Department of Labor’s (DOL’s) Employee Benefits Security Administration (EBSA) recently issued a final regulation to enhance retirement security by improving workers’ access to quality fiduciary investment advice. The Pension Protection Act of 2006 created this concept and charged the DOL with writing regulations to establish a prohibited transaction exemption. The effective date of this regulation was December 27, 2011.
An “eligible investment advice arrangement” means an arrangement that meets the requirements of the fee-leveling arrangement in DOL regulation Section 2550.408g–1(b)(3) or that meets the computer model arrangement in DOL regulation Sec. 2550.408g–1(b)(4).
Under the final regulation, investment advice may be given in one of two ways for a plan to qualify for the exemption:
- Through the use of a computer model that is certified as unbiased by an independent expert, or
- By an adviser who is compensated on a “level-fee” basis, meaning that the fees do not vary based on the investments participants select
Either type of investment advice arrangement must also satisfy several other conditions, including the disclosure of the adviser’s fees and an annual audit of the arrangement to ensure compliance.
The final regulation states that all prior DOL investment advice regulations, exemptions, interpretive, or other guidance is to remain effective. So Advisory Opinion (AO) 2001-09A to SunAmerica that was in regard to an asset allocation portfolio designed to use a computer program developed, maintained, and monitored by a financial expert independent of SunAmerica Retirement Markets Inc. is still effective and, in fact, the regulations are similar to this AO. The regulation reiterates that nothing under the Employee Retirement Income Security Act (ERISA) requires a plan fiduciary to offer investment advice to participants and beneficiaries. The regulation provides that any plan sponsor that prudently selects and monitors an investment adviser will not be liable for the investment advice provided by that adviser to plan participants/beneficiaries.
The following is a detailed presentation of the regulatory information.
Requirements for All Eligible Investment Advice Arrangements
Plan Fiduciary Authorization
The eligible investment advice arrangement (EIAA) must be expressly authorized by a plan fiduciary (other than the person offering the arrangement, any person providing investment options, or affiliates of either). An exception applies where investment advice is offered to participants and beneficiaries of a plan sponsored by the person offering the EIAA, if the same EIAA is offered to participants and beneficiaries of unaffiliated plans in the ordinary course of its business.
The final rule enumerates certain basic information about the EIAA that must be included in the audit report. Note that the auditor is not considered a fiduciary of the plan. At least annually, the fiduciary adviser will engage an independent auditor to review the arrangement to see that it is in compliance with the final regulation and provide a written report to the fiduciary adviser and to each fiduciary who authorized the use of the arrangement, within 60 days after completing the audit.
The fiduciary adviser must, prior to providing advice, disclose in writing, without any charge, to the participant information including, but not limited to: the role of any party that has a material relationship to the fiduciary adviser with regard to the development of the EIAA or selecting the investment options; past performance and historical rates of return of the investment options offered under the plan; fees or compensation the adviser will receive; the types of services the adviser provides in connection with the provision of investment advice; and that the adviser is acting as a fiduciary of the plan.
The fiduciary adviser must provide the authorizing fiduciary with a written notice informing the fiduciary that the fiduciary adviser intends to comply with the statutory exemption for investment advice under ERISA Sec. 408 and the conditions of this regulation. The fiduciary adviser must maintain records that demonstrate the prohibited transaction requirements were met for a period of at least six years.
Arrangements Using Fee-leveling
A fee-leveling arrangement is one in which the fiduciary adviser (including any employee, agent, or registered representative) who provides investment advice may not receive from any party (including an affiliate of the fiduciary adviser), directly or indirectly, any fee or other compensation (including commissions, salary, bonuses, awards, promotions, or other things of value) that varies depending on the basis of a participant’s or beneficiary’s selection of a particular investment option. Additionally:
- The investment advice is based on generally accepted investment theories that take into account the historic risks and returns of different asset classes over defined periods of time (nothing in the regulation precludes any investment advice based on generally accepted investment theories that take into account additional considerations)
- Any investment advice takes into account investment management and other fees and expenses attendant to the recommended investments
- Any investment advice takes into account, to the extent furnished by a plan, participant or beneficiary, information relating to age, time horizons (e.g.,life expectancy, retirement age), risk tolerance, current investments in designated investment options, other assets or sources of income, and investment preferences of the participant or beneficiary
- A fiduciary adviser shall request such information, and take into account information furnished by a participant or beneficiary
Arrangements Using Computer Models
An arrangement is an EIAA if the only investment advice provided under the arrangement is advice that is generated by a computer model described in this regulation. As such, a computer model shall be designed and operated to:
- Apply generally accepted investment theories (which are not defined) that take into account the historic risks and returns of different asset classes over defined periods of time (although nothing herein shall preclude a computer model from applying generally accepted investment theories that take into account additional considerations)
- Take into account investment management and other fees and expenses attendant to the recommended investments
- Appropriately weight the factors used in estimating future returns of investment options (including historical performance)
- Utilize appropriate objective criteria to provide asset allocation portfolios comprised of investment options available under the plan
- Avoid investment recommendations that:
- Inappropriately favor investment options offered by the fiduciary adviser or affiliates, or
- Inappropriately favor investment options that may generate greater income for the fiduciary adviser or affiliates, and
- Take into account all designated investment options available under the plan without giving inappropriate weight to any investment option. This includes employer securities and target date funds. Excluded are self-directed brokerage accounts, brokerage windows, and similar arrangements.
Additional Requirements for Arrangements Using Computer Models
- Adviser will request from a participant/beneficiary information needed to provide advice, such as age, time horizons (e.g.,life expectancy, retirement age), risk tolerance, current investments in designated investment options, other assets or sources of income, and investment preferences; provided, however, that nothing herein shall preclude a computer model from requesting and taking into account additional information that a plan or a participant or beneficiary may provide
- In-plan annuity option used toward the purchase of a stream of retirement income payments guaranteed by an insurance company does not have to be included, but may be included, provided that when the computer generated model is provided to the participant/beneficiary, it is accompanied by a description of the annuity options and how they operate
- The model may exclude an investment option that the participant/beneficiary requests to be excluded from consideration
- Prior to using the computer model, the fiduciary adviser is required to obtain a written certification (as described in the regulation) from an eligible investment expert that the computer model meets the requirements of regulations
- An eligible investment expert is defined as a person who has the appropriate technical training or experience and proficiency to analyze, determine, and certify, in a manner consistent with the regulations, whether the computer model satisfies the requirements of the regulations. No further delineation of how to become qualified as an eligible investment expert is provided. However, an eligible investment expert does not include any person who:
- Has any material affiliation or material contractual relationship with the fiduciary adviser, with a person with a material affiliation or material contractual relationship with the fiduciary adviser, or with any employee, agent, or registered representative of the foregoing, or develops a computer model utilized by the fiduciary adviser to satisfy this regulation
- A certification by an eligible investment expert shall be in writing and contain how each of the following meet the regulation’s requirements:
- An identification of the methodology or methodologies applied in determining whether the computer model meets the requirement of the regulations
- Demonstration of the methodology or methodologies used by the model
- A description of any limitations imposed by any person on the eligible investment expert’s selection or application of methodologies for determining whether the computer model meets the regulations’ requirements
- A representation that the methodology or methodologies were applied by a person(s) with the educational background, technical training or experience necessary to analyze and determine that the computer model complies with the regulations
- A statement certifying that the eligible investment expert has determined that the computer model meets the requirements of paragraph (b)(4)(i) of the regulations
- Signature of the eligible investment expert
- Selection of an eligible investment expert as required by this section is a fiduciary act governed by Sec. 404(a)(1) of ERISA.
McKay Hochman Co., Inc. (MHCO), is one of America’s most respected and recognized consulting firms serving the employee benefits field. Since 1979, the firm has built its reputation as an innovator in developing unique products and technical services to help clients establish and administer IRS-approved retirement plans. MHCO has created a niche as an expert prototype plan Mass Submitter serving financial institutions, attorneys, accountants, and consultants throughout the United States. To learn more, call 973-492-1880 or e-mail firstname.lastname@example.org.
©2012, McKay Hochman Co., Inc. All rights reserved. Reprinted with permission.
Rev. 04/25/12; E-mail Alert 2012-4