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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
The Department of Labor (DOL) has issued proposed regulations and a proposed class prohibited transaction exemption (Class PTE) on the provision of investment advice for self-directed individual account plans and individual retirement accounts (IRAs). The guidance is intended to expand opportunities for plan fiduciaries to provide investment advice to plan participants and beneficiaries without running afoul of prohibited transactions rules. The rules would be effective 60 days after publication as final regulations and, thus, may not be relied on currently.
Generally, under the prohibited transaction provisions of ERISA, fiduciaries are prohibited from rendering advice to plan participants regarding investments that result in the payment of additional fees to the fiduciaries or their affiliates. As a result of these provisions, plan fiduciaries largely avoided providing advice to participants regarding investments in self-directed plans and IRAs.
According to the DOL, there is evidence that, without expert investment advice, many participants and beneficiaries in self-directed plans and IRAs make poor investment decisions, such as paying higher fees and expenses than necessary for investment products and services, engaging in excessive or poorly timed trading, failing to rebalance their portfolios, inadequately diversifying their portfolios and thereby assuming uncompensated risk, and paying unnecessarily high taxes. With an increasing proportion of retirement funds in such plans, and a recognition that participants and beneficiaries of such plans were foregoing earnings and incurring losses which were avoidable with professional investment advice, the Pension Protection Act of 2006 (PPA; P.L. 109–280) made amendments to ERISA intended to permit a broader array of investment advice providers to offer their services to participants and beneficiaries responsible for investment of assets in their individual accounts. The DOL estimates that the proposals will improve investment results for retirement plan participants by an aggregate of approximately $14 billion annually, at a cost of $4 billion annually, resulting in a net annual financial benefit of $10 billion or more.
These proposals are intended to implement changes made to ERISA §408(b)(14) and ERISA §408(g) by the PPA. ERISA §408(b)(14) provides an exemption from certain prohibited transaction provisions in ERISA with respect to the provision of investment advice, and the direct or indirect receipt of fees or other compensation by the fiduciary adviser or an affiliate. ERISA §408(g) describes the conditions under which the investment advice-related transactions are exempt.
In order to fall within the exemption, the investment advice must be provided by a fiduciary advisor under an “eligible investment advice arrangement.” Under an eligible investment advice arrangement, (1) portfolio recommendations are based on a computer model that has been audited by a third party, or (2) a fiduciary advisor provides investment advice services by charging a flat fee (i.e., “fee leveling”). These requirements are designed to safeguard against a firm’s creation of incentives for individuals to recommend certain investment products.
For investment advice arrangements to be eligible for an exemption to the prohibited transaction rules based upon fee-leveling, the investment advice must be based upon generally accepted investment theories which take into account the historic returns of different asset classes over defined periods of time, and which take into account information regarding the individual participant’s age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and investment preferences. Other considerations may also be taken into account. The proposed regulations put the burden upon the fiduciary to insist that the investment advisor adhere to these requirements.
Second, the fee-leveling aspect of these arrangements requires that any fees or other compensation (including salary, bonuses, awards, promotions, commissions or other things of value) received, directly or indirectly, by any employee, agent or registered representative that provides investment advice on behalf of a fiduciary adviser must not vary depending on the basis of any investment option selected by a participant or beneficiary. Further, any fees (including any commission or other 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 investment of plan assets must not vary on the basis of any investment option selected by a participant or beneficiary. Note: affiliates of the fiduciary advisor are not included in this prohibition, according to the DOL, unless the affiliate is also a provider of investment advice to a plan.
For investment advice arrangements to be exemption-eligible based upon computer-modeling, the computer model, just as under the fee-leveling arrangement, must apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time, and utilize information furnished by a participant or beneficiary relating to age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and investment preferences. As with fee-leveling, other considerations may also be taken into account. Appropriate objective criteria to provide asset allocation portfolios comprised of investment options available under the plan must be utilized.
The computer model must also be designed and operated to avoid investment recommendations that inappropriately favor investment options offered by the fiduciary adviser over other available investment options, or which may generate greater income for the fiduciary adviser. Computer models must take into account all “designated investment options” available under the plan without giving inappropriate weight to any particular option.
Self-directed brokerage accounts and the like, which allow the selection of investments beyond those designated by the plan, do not qualify as a designated investment option. Computer models are not required to include investments in employer securities as a designated investment option.
Prior to using an investment advice arrangement based upon computer-modeling, the fiduciary advisor must obtain a written certification from an “eligible investment expert” that the computer model to be utilized meets the regulatory requirements. The proposed regulations do not specify a methodology for this certification.
Other than specifying that an “eligible investment expert” may not have a material relationship with the fiduciary advisor, the proposed regulations also do not define a specific set of academic or other credentials that would serve to define the appropriate expertise and experience for an eligible investment expert. Instead, the proposed regulations place the burden on the fiduciary advisor to determine whether an eligible investment expert possesses the requisite training and experience to determine whether a computer model meets the regulatory requirements.
Both fee-leveling and computer-modeling investment advice arrangements must also:
- be authorized by the plan fiduciary;
- undergo an annual audit by an independent auditor;
- disclose to plan participants and beneficiaries, prior to the initial provision of investment advice, such factors as the role which any party who has a material affiliation with the fiduciary advisor had in developing the investment advice program or selecting investment options (note: the proposed regulations contain an optional model disclosure form that will meet this requirement); and
- maintain, for a minimum of 6 years after the provision of investment advice, records necessary to determine whether the regulatory requirements have been met.
Along with the proposed regulations, the DOL issued a proposed Class PTE which would permit advisors to provide individualized investment advice to a participant after providing advice generated by use of a computer model, or, in the case of IRAs for which modeling is not feasible, the furnishing of certain investment education material. The DOL believes that plan participants and beneficiaries may want the flexibility to obtain other investment advice after receiving computer-generated advice, and advisers may be willing to offer such services.
The general requirement for computer model investment advice set forth in the class PTE also applies to IRAs, unless the fiduciary adviser determines that the types or number of investment choices available to an IRA beneficiary reasonably precludes the use of a computer model meeting the regulatory requirements. In that case, the beneficiary must be provided certain investment education-type materials, such as worksheets or interactive software, which reflect or produce asset allocation models taking into account the age and risk profile of the beneficiary.
The proposed class PTE applies the fee-leveling limits solely to the compensation received by the employee, agent or registered representative providing the advice on behalf of the fiduciary adviser, and not to compensation received by the fiduciary adviser on whose behalf the employee, agent or registered representative is providing such advice. According to the DOL, the safeguards provided for in the class exemption are 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 objective investment advice for participants and beneficiaries.
Comments on the proposed regulations or the proposed Class PTE must be submitted by October 6, 2008: by e-mail to e- ORI@dol.gov (with a Subject line stating, respectively, “Investment Advice Regulations” or “Investment Advice Class Exemption”), by using the Federal eRulemaking portal at http://www.regulations.gov, or by mail to the Office of Regulations and Interpretations, Employee Benefits Security Administration, (with an Attention line stating, respectively, “Investment Advice Regulations” or “Investment Advice Class Exemption”), Room N–5655, U.S. Department of Labor, 200 Constitution Avenue NW, Washington DC 20210.
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