Final DOL Investment Advice Regulations

On October 25, the Department of Labor (DOL) published final regulations on the provision of investment advice to individual account plan (generally defined contribution or DC plan) participants and beneficiaries. You can read those regulations yourself on the DOL website, you can get a highly technical explanation on the website of most law firms that have an ERISA practice, or you can read about them here. I know which one will be the easiest read for you.

These regulations have an interesting genealogy. They implement provisions of the Pension Protection Act of 2006 (PPA). Proposed regulations were first issued under the Bush administration in 2008, withdrawn and reproposed under the Obama administration in 2010 and have now been finalized.

In discussing this final regulation, I am going to refer to the 2010 proposed regulations as a starting point. For those who are not familiar with the proposed regulations, I would love to refer you to an earlier blog post, but I wasn't blogging then. In any event, I think you'll get the gist as you go along.

Generally, providing advice of this type to plan participants [or beneficiaries] would be a prohibited transaction under ERISA (from here forward in this post, when I refer to participants, that term will include beneficiaries unless I say otherwise). However, PPA provided an exemption for two specific types of advice -- model-driven and flat-fee. The final regulations make two noteworthy changes (a few readers may not agree that the second one is a change, but just a re-interpretation) for model-driven advice.

• To the extent that employer securities are an investment option, they must be included in the model unless the participant directs otherwise. I'm not sure how this can be effectively implemented.
• The proposed regulations indicated, at least to me, that a model could not consider historical returns. Again, to me, this would have directed a bias toward index funds. While index funds may be very appropriate, a regulated bias to them seems inappropriate. The final regulations change the language so that any "generally accepted investment theories" may be used. Presumably, this would include a reference to historical returns.

Again, the statute and regulations under PPA allow for two types of what I have referred to as conflicted advice. That is, it is advice that would be provided by someone who may not be an independent third party. The exemption for flat-fee advice is largely what it seems. To qualify, it must satisfy four pretty simple criteria:

• At a minimum, it uses generally accepted investment theory to take into account historic risk and returns of various asset classes over defined periods of time.
• It takes into account fees and expenses associated with the investments.
• The adviser must solicit pertinent information from the participant and the participant must provide that information. At a minimum, that information includes:
• age
• information that could relate to life expectancy
• current investment options
• tolerance for risk
• investment style or preferences
• other assets and sources of income
• other information that seems relevant
• The adviser receives no direct or indirect compensation for this advice other than a fixed fee from the participant.

A computer model in order to qualify must satisfy seven basic criteria:

• At a minimum, it uses generally accepted investment theory to take into account historic risk and returns of various asset classes over defined periods of time.
• It takes into account fees and expenses associated with the investments.
• Weight the factors 'appropriately' (whatever that means) used to estimate future returns of the various investment options under the plan.
• The adviser must solicit pertinent information from the participant and the participant must provide that information. At a minimum, that information includes:
• age
• information that could relate to life expectancy
• current investment options
• tolerance for risk
• investment style or preferences
• other assets and sources of income
• other information that seems relevant
• Use appropriate (undefined term) criteria to develop portfolios of available investment options under the plan.
• Ensure that there is no bias to recommending investment options that may financially favor the financial adviser or an affiliate.
• Consider all investment options under the plan [including company stock] unless the participant asks that particular options be excluded from consideration.

Because the final regulations require model-driven advice to consider all available investment options under the plan (unless the participant requests otherwise), I would read this to include all employer securities and target date funds (TDFs). In fact, the regulations say that "The Department [of Labor] believes that it is feasible to develop a computer model capable of addressing investments in qualifying employer securities, and that plan participants may significantly benefit from this advice. The Department also believes that participants who seek investment advice as they manage their plan investments would benefit from advice that takes into account asset allocation funds, if available under the plan. Based on recent experience in examining target date funds and similar investments, the Department believes it is feasible to design computer models with this capability."

I am glad that the DOL finds this to be feasible.

Finally, the producer of a computer model to be used to provide investment advice must receive a written certification that the model meets all of the applicable requirements from an independent (independence was not in the proposed regulation) eligible investment expert. Such expert must have the requisite technical training or experience and proficiency to make such certification. [I have no idea who makes the decision on whether or not the expert has these amorphous qualifications.]

Such certification (not a fiduciary act according to the regulation) must include the following:

• Identification of the methodology(ies) used to determine that the model meets the applicable requirements.
• An explanation of how those methodologies show that the model meets those requirements.
• An explanation of limitations, if any, that were placed on the eligible expert in making his or her determination.
• A representation that the expert has the requisite training or experience and proficiency to make such determination.
• A statement that the expert has determined that the model meets all of the applicable requirements.

In jest, perhaps an expert is anyone who can figure out how to do an appropriate certification.

To qualify for either exemption, advice must meet a five-prong test:

1. It must be authorized by a plan fiduciary not related to the adviser
2. It must be independently audited annually with the audit results issued to the adviser and the plan fiduciary. The fiduciary adviser selects the adviser who notifies the authorizing fiduciary of the audit requirements.
3. The fiduciary adviser must provide appropriate disclosures to comply with all securities laws.
4. The transaction must occur at the sole discretion of the requestor.
5. Compensation must be reasonable and no less favorable to the plan than an arm's length transaction.

The regulations also specify a plethora of requirements related to disclosure and record maintenance. So, once again, a participant being advised under one of these exemptions will be given a host of forms to [just] sign before being given advice. Perhaps more useful would be the adviser having a discussion about this information with the participant and the participant making an affirmative statement in writing that such conversation had taken place, but I don't write the regulations.

Failure to comply with these regulations would result in an excise tax of 15% of the amount of the prohibited transaction. The DOL views this as putting significant teeth in the regulation. I am less than convinced. 

In any event, the regulations are effective 60 days after publication in the Federal Register. I have yet to see people lined up waiting to use them.