5500 Preparer's Manual for 2012 Plan Years
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The Department of Labor's Employee Benefits Security Administration (EBSA) has issued proposed regulations implementing provisions of the Pension Protection Act of 2006 (PPA; P.L. 109-280) that authorize fiduciary advisers to provide individualized investment advice to participants and beneficiaries in individual account plans, such as 401(k) plans, and beneficiaries of IRAs. The proposed regulations would define the scope of the fee leveling requirements under an eligible investment advice arrangement; specify the requirements for the certification of model investment advice programs; set forth the conditions under which a fiduciary adviser may elect to be the sole plan fiduciary; explain the circumstances under which an auditor will be deemed sufficiently independent to review an investment arrangement; and provide a nonmandatory Model Fiduciary Adviser Form for the disclosure of fees, compensation and services.
The DOL advises that the proposed regulations are "nearly identical" to final regulations implementing the statutory exemption promulgated under the PPA that were issued in January 2009, but subsequently withdrawn in November 2009. In addition, the DOL explanation of the final regulations contained in the Preamble continues to apply to provisions under the proposed regulations. However, the proposed rules, reflecting DOL concern over investment adviser self-dealing, do not retain the Class Exemption included in the 2009 final regulations that would have established alternative conditions for granting prohibited transaction relief in connection with the provision of investment advice.
The proposed regulations, despite their similarity to the withdrawn 2009 rules, do not afford immediate reliance and will not be effective until 60 days after they are issued in final form. The DOL will accept comment on the proposed rules until May 5, 2010. Note: the request for comment is unusually specific and directed, which suggests that the DOL may be looking to expand the scope and detail of the regulatory requirements.
In the event certain requirements are met, the proposed regulations would exempt the following from treatment as a prohibited transaction: (1) the provision of investment advice to a participant or beneficiary regarding any security or property available as a plan investment; (2) the acquisition, holding or sale of a security, or other property available as an investment under the plan pursuant to the investment advice; or (3) the direct or indirect receipt of fees or other compensation by a fiduciary adviser, or its affiliate (or an employee, agent, or registered representative of the fiduciary 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 investment advice.
Eligible investment advice arrangement
The proposed rules apply to investment advice offered by a fiduciary adviser under an "eligible investment advice arrangement." An eligible investment advice arrangement either: (1) provides that any fees (including any commissions or 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 the investment of plan assets do not vary depending on the basis of the investment option selected (i.e., fee leveling), or (2) uses a computer model under an investment advice program meeting specified requirements in connection with the provision of investment advice by a fiduciary adviser to a participant or beneficiary.
Investment advice provided under a fee leveling arrangement must be based on generally accepted investment theories that take into account the risks and returns of different asset classes over a defined period of time (although additional factors may be considered). In addition, the proposed rules would require the adviser to take into account personal information that is actually furnished by the participant or beneficiary (at the request of the fiduciary adviser) that relates to the individual's age, time horizon (e.g., life expectancy and retirement age), risk tolerance, current investment in designated investment options, other assets or sources of income, and investment preferences. Note, the fiduciary adviser would not be required to consider information that is requested but not provided.
The central focus of the provisions of the proposed regulations dealing with fee leveling arrangements, however, is on the fees and compensation charged for investment advice. Accordingly, the proposed regulations (similar to the withdrawn final rules) would require that any investment advice under a fee leveling arrangement (and a computer model) take into account investment management and other fees and expenses attendant to the recommended individualized investments.
Under the withdrawn final regulations, any fee or other compensation (including salary, bonuses, awards, promotions, commissions, or other things of value (e.g., trips, gifts, other items of value not given in cash)) received directly or indirectly by an employee, agent, or registered representative that provided investment advice on behalf of a fiduciary adviser could not vary on the basis on any investment option selected by a participant or beneficiary. Moreover, fees (including any commissions or other compensation) received by a fiduciary adviser for investment advice or with respect to the sale, holding, or acquisition of any security or other property for purposes of the investment of plan assets could not vary on the basis of any investment option selected by a participant or beneficiary.
However, the final rules only applied to fees or other compensation of fiduciary advisers. EBSA concluded that Congress did not intend for the level fee requirement to extend to affiliates of the fiduciary adviser, unless the affiliate was also the provider of investment advice to the plan. This interpretation raised the concern that, by allowing for the receipt of varying fees by an affiliate, the final rules authorized an affiliate of a fiduciary adviser to establish economic incentives for either the fiduciary adviser, or individuals providing investment advice on its behalf, to recommend investments that pay varying fees to the affiliate.
In addressing this concern, the proposed regulations stress that no fiduciary adviser (including an employee, agent, or registered representative) that provides investment advice may 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 is based, in whole or in part, on the participant's or beneficiary's selection of an investment option. Pursuant to this condition, the DOL explains, although an affiliate of a fiduciary adviser may receive fees that vary depending on the investment option selected, any provision of financial or economic incentives by an affiliate (or other party) to a fiduciary adviser or any individual employed by the fiduciary adviser (e.g., an employee providing advice on its behalf or an individual responsible for supervising such an employee) to favor certain investments would not be permitted.
Computer model for investment advice. Investment advice may be provided under an eligible investment advice arrangement that uses a qualified computer model. Under the proposed rules, the computer model must:
1. apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time (although other factors may be taken into consideration);
2. take into account investment management and other fees and expenses attendant to the recommended investments;
3. use relevant information (requested by the fiduciary adviser and actually furnished by the participant or beneficiary) about the participant or beneficiary, including age, time horizon (e.g., life expectancy and retirement age), risk tolerance, current investments in designated investment options, other assets or sources of income, and preferences as to certain types of investments;
4. use prescribed objective criteria to provide asset allocation portfolios comprised of investment options available under the plan;
5. avoid investment recommendations that inappropriately favor investment options offered by the fiduciary adviser or that may generate income for the fiduciary adviser or those with a material affiliation or material contractual relationship with the fiduciary adviser; and
6. take into account all designated investment options under the plan (excluding brokerage windows and self-directed brokerage accounts) in specifying how a participant's account balance should be invested, and not give inappropriate weight to any investment option.
Program must be authorized by separate plan fiduciary
Under the proposed regulations, an eligible investment advice arrangement would need to be expressly authorized by a plan fiduciary (or the beneficiary of an IRA). The arrangement could not be authorized by the person offering the investment advice program, any person providing designated investment options under the plan, or an affiliate of either of those parties. However, a plan sponsor would not, under the proposed rules, be treated as providing a designated investment option merely because one of the designated investment options of the plan allows investment in the securities of the sponsor or an affiliate.
Notice and disclosure requirements
Prior to providing investment advice about securities or other property offered as an investment option, the fiduciary adviser would be required under the proposed rules (as under the withdrawn final regulations ) to furnish (without charge) a participant or beneficiary with written notification (which may be in electronic form), disclosing:
1. the role of any party having a material affiliation or contractual relationship with the financial adviser in the development of the investment advice program and the selection of available investment options under the plan;
2. the past performance and historical rates of returns of the designated investment options offered under the plan (to the extent the information is not otherwise provided);
3. all fees or other compensation to be received by the financial adviser or its affiliates (including any compensation provided by a third party) in connection with: (a) the provision of the advice; (b) the sale, acquisition or holding of the security or other property pursuant to such advice (including those made through an open brokerage window or directed brokerage account); or (c) any rollover of the distribution of plan assets or the investment of distributed assets in any security or other property pursuant to such advice;
4. any material affiliation or contractual relationship of the financial adviser or affiliates in the security or other property involved in the investment transaction;
5. the manner and circumstances under which any participant or beneficiary information will be used or disclosed;
6. the types of services provided by the fiduciary adviser with respect to the advice given (including any limits on the ability of a computer model to account for investments primarily in employer securities);
7. the fact that the adviser is acting as a fiduciary of the plan with respect to the provision of investment advice; and
8. the right of the recipient of the advice to enter into a separate arrangement with another adviser that has no material affiliation with, and receives no compensation with respect to, the security or other property.
Model Fiduciary Adviser Disclosure Form
The proposed regulations provide a model form that could be used by fiduciary advisers in order to satisfy the fee and compensation disclosure requirements. The model disclosure form would require a fiduciary adviser who is compensated by the plan to detail the manner in which compensation is charged (e.g., asset-based fees, flat fees, or per advice basis). In addition, the form would require disclosure of the percentage range by which the fees assessed would vary depending on the investment option selected.
Requests for comment on proposed rules
The DOL is making a specific request for public comment on conditions applicable to investment advice arrangements that use computer models. Specifically, the DOL is requesting comment on whether the final regulations should: require (or proscribe) the use of specified investment theories and practices; specify minimum standards (e.g., minimum number of years of experience) for historical data that is taken into account in determining a model's expectation for the future performance of asset classes and specific investment alternatives; or expressly designate the criteria that are appropriate and objective bases for asset allocation.
In addition, the DOL is interested in comment on issues such as whether: a fund's past performance relative to the average for its asset class is an appropriate criterion for allocating assets to the fund; it would be consistent with generally applicable investment theory to recommend a fund with superior past performance over an alternative fund in the same asset class with average performance but lower fees; or a model should ascribe different levels of risk to passively and actively managed investment options.
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