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News November 14, 2011 Issue

DOL’s Participant Advice Rule Arrives

Plan fiduciaries canít give plan participants advice Ė except when they can. Itís all about the exemptions, and now we know what they are.

On October 25, the Department of Labor (DOL) published final Rule 408g-1 under ERISA, which expands the availability of investment advice to participants in defined contribution plans. The rule provides exemptions to the general prohibition against any plan fiduciary receiving fees for providing advice to plan participants.

If it feels like dťjŗ vu, youíre right. The rule was originally adopted on January 21, 2009, but after a number of concerns were raised, the rule was first delayed and then ultimately withdrawn in November 2009.

After several months of reconsideration, the rule was reproposed on March 2, 2010 for comment.

The final rule this time looks a lot like the March 2010 proposal.

"Generally accepted investment theories" remain in the rule.

Despite strong industry objection, DOL retained a requirement that any advice provided be based on generally accepted investment theories (GAITs).

During the comment period, the Securities Industry and Financial Markets Associationís Liz Varley observed that "[t]he risk in expressly designating what criteria should be used Öis that important criteria may be omitted." Similarly, Investment Adviser Association general counsel Karen Barr noted that decision-making criteria that is codified in regulation is inherently inflexible and canít be readily modified under changing circumstances. The prudent person standard is not "one-size-fits-all," she said.

DOL did not specify a definition for any GAITs, but required that the GAIT be certified as such by an expert that is independent of the fiduciary adviser. The expert must provide a written report that the fiduciary adviser must retain for at least six years.

"As the party seeking prohibited transaction relief under the exemption, the fiduciary adviser has the burden of demonstrating satisfaction of all applicable requirements of the exemption," said DOL. The certification requirement directly supports that burden.

DOL, in a baffling rationale, said "the Department does not believe it has a sufficient basis for determining appropriate changes to the generally accepted investment theory standard." Many commenters offered up theories and practices they believe are generally accepted, but "there did not appear to be any consensus among them, with the exception of modern portfolio theory," said DOL.

Therefore, the requirement to base advice on GAITs remains in the rule unchanged, and includes a requirement that the GAIT be certified in a written report by an expert that is independent of the fiduciary adviser.

Arrangements using fee-leveling.

No matter the advice provided, under a fee-leveling arrangement the adviserís and its employeesí compensation Ė direct or indirect Ė may not vary. An affiliate is not bound by this requirement, and may receive commissions, for example, or other compensation related to services provided as a result of the advice.

Advice provided under a fee-leveling arrangement must take into account, to the extent furnished, information relating to:

  • Age;
  • Time horizons (e.g. life expectancy, retirement age, etc.);
  • Risk tolerance;
  • Current investments in designated investment options;
  • Other assets or sources of income; and
  • Preferences of the participant or beneficiary.

"Despite a request for reconsideration from commenters, paragraph (b)(3)(i)(C) requires that a fiduciary adviser request such information," said the release.

Arrangements using computer models.

The second eligible arrangement under the final rule allows advice provided by a computer-generated model that uses objective criteria to recommend an allocation of available plan investment options. The model must also be designed to avoid "inappropriately" favoring investment options offered by the fiduciary adviser or certain other persons.

"A computer model must be designed and operated to avoid investment recommendations that inappropriately distinguish among investment options within a single asset class on the basis of a factor that cannot confidently be expected to persist in the future," said the rule release.

Historical performance is a legitimate factor when determining an appropriate mix of asset classes, but is "less likely to constitute appropriate criteria" for use when selecting among investments within a single asset class.

The DOL explained that within an asset class, such differences as fees and expenses or management style would be appropriate criteria for asset allocation, but "other differences, such as differences in historical performance, are less likely to persist and therefore less likely to constitute appropriate criteria for asset allocation; asset classes, in contrast, can more often be distinguished from one another on the basis of differences in their historical risk and return characteristics."

The provision in the rule is not intended to preclude any consideration of an investment optionís historical performance, said the DOL. Rather, "the provision is intended to ensure that in evaluating investment options for asset allocation, it would be appropriate and consistent with GAITs for a computer model to take into account multiple factors, including historical performance, attaching weights to those factors based on surrounding facts and circumstances."

Target date funds and qualifying employer securities are in.

The final rule requires a computer model to include target date funds and qualifying employer securities in its analysis of available investment options. The proposed rule excepted these investments from mandatory consideration, along with annuity products. Commenters successfully persuaded the DOL that computer modeling accounting for qualifying employer securities can help avoid potential overconcentration issues. Commenters also convinced the DOL that if target date funds were excluded, interested participants would need to conduct their own research on "these popular investments."

Annuities, however, didnít make the cut. The DOL was confident that computer modeling capabilities could account for target date and employer securities parameters. However, the DOL was "less certain" that computer models are able to give adequate consideration to in-plan annuity products, and was hesitant to mandate their inclusion in any computer model.

The DOL noted that a computer model was not precluded from considering annuity products in the allocation among plan investment options, and that "amounts that a participant or beneficiary have already allocated to such an annuity must be taken into account by the computer model in developing the recommendation with respect to the investment of the participantís remaining available assets."

Annual audit requirement remains.

Although some industry observers, like law firm Stroock & Stroock & Lavan, view the requirement as effectively an "audit say-on-pay," the DOL retained the annual audit requirement as proposed.

The annual audit must be conducted by an independent auditor with "appropriate technical training or experience and proficiency." The auditor must provide a written report of its findings within 60 days of completing the audit that identifies the fiduciary adviser and the type of arrangement Ė fee leveling, computer model, or both. The report must also include the date of the most recent computer model certification, if any.

The report must be delivered to each fiduciary who authorized the use of the investment advice arrangement. IRAs are excluded from this direct delivery requirement given their significant numbers, and the fiduciary adviser may make the report available to IRA beneficiaries through the adviserís website or through other designated means.

Effective date.

Although at least one commenter asked for six months to prepare for compliance with the rule, the DOL stuck with its originally proposed two months, "given the importance of investment advice to participants and beneficiaries generally and given that the exemption implemented in the final rule will expand the opportunity for participant and beneficiaries to obtain affordable, quality investment advice." Specifically, 60 days after the ruleís October 25th publication in the Federal Register, the rule will be effective.

Thatís Saturday, December 24, for all you calendar counters out there.