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CCH® PENSION — 11/09/11

EBSA issues final rules allowing for personalized investment advice under eligible investment advice arrangements

The Employee Benefit Security Administration (EBSA) has issued final regulations implementing provisions of the Pension Protection Act of 2006 (PPA; P.L. 109-280) that authorize fiduciary advisers to provide individualized investment advice under eligible investment advice arrangements. The final regulations: 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 voluntary Model Fiduciary Adviser Form for the disclosure of fees, compensation and services.

The rules will be effective December 27, 2011. Phyllis Borzi, EBSA Assistant Secretary explains that the relatively accelerated effective date is due to the fact that compliance with the Prohibited Transaction Exemption being implemented is voluntary. In addition, the early effective date will allow employers to begin providing much needed investment advice for employees on an expedited basis.

The PPA (effective for investment advice provided after 2006) authorized a prohibited transaction exemption that allows "fiduciary advisers" to provide individualized investment advice for a fee to plan participants and beneficiaries under an eligible investment advice arrangement, pursuant to which: (1) portfolio recommendations are generated based on an unbiased computer model that has been audited by an independent third party, or (2) a fiduciary adviser provides investment advice services by charging a flat fee that does not vary depending on the investment option selected by participants (i.e., fee level basis).

Scope of investment advice exemption

The statutory exemption applies to investment advice offered by a fiduciary adviser under an eligible investment advice arrangement to participants and beneficiaries in individual account plans (such as 401(k) plans and IRAs) who are authorized to direct the investment of assets in their individual accounts. Note, the relief does not apply to investment advice provided to plan sponsors and other fiduciaries, but is limited to the recommendations of investment managers to participants and beneficiaries.

CCH Note: The final regulations clarify that the conditions of the rules apply only to investment advice that would constitute a prohibited transaction. In addition, the final regulations stress that a plan fiduciary is not statutorily obligated to offer, provide, or otherwise make available investment advice to a participant or beneficiary.

Fiduciary advisers

A fiduciary adviser, for purposes of the PT exemption, is a person who is a plan fiduciary because of the provision of investment advice to participants or beneficiaries. Note, plan sponsors may not be fiduciary advisers.

The fiduciary adviser is further defined, under the final rules, as:

1. a registered investment adviser under the Investment Advisers Act of 1940 or under laws of the state in which the fiduciary maintains its principal office and place of business;
2. a bank, a similar financial institution supervised by the United States or a state, or a savings association (as defined under the Federal Deposit Insurance Act), but only if the advice is provided through a trust department of the institution that is subject to periodic examination and review by federal or state banking authorities;
3. an insurance company qualified to do business under state law;
4. a person registered as a broker or dealer under the Securities Exchange Act of 1934;
5. an affiliate of any of the preceding entities (as defined under Sec. 2(a)(3) of the Investment Company Act of 1940);
6. an employee, agent or registered representative (as defined under Sec. 3(a)(18) of the Securities Exchange Act of 1934 or Sec. 202(a)(17) of the Investment Advisers Act of 1940) of any of the preceding who satisfies the requirements of applicable insurance, banking and securities laws relating to the provision of advice.

An affiliate is defined as any person directly or indirectly owing, controlling, or holding with power to vote, 5 percent or more of the outstanding voting securities of such other person; any person 5 percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote by such other person; any person directly or indirectly controlling, controlled by, or under common control with such other person; and any officer, director, partner, co-partner, or employee of such other person.

A person who develops the computer model or markets the investment advice program or computer model will be treated as a plan fiduciary by reason of the provision of investment advice and is treated as a fiduciary adviser. However, ERISA §408(g)(11)(A) and Code Sec. 4975(f)(8) allow for one fiduciary adviser to elect to be treated as the sole fiduciary. This provision effectively narrows the scope of the fiduciary status that otherwise obtains to those developing the computer model, but does not affect the fiduciary responsibilities of those actually providing investment advice.

Eligible investment advice arrangement

The PT exemption applies 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 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.

Fee leveling requirements. 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 final 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 must request the information, but would not be required to consider information that is requested but not provided.

The central focus of the provisions of the final regulations dealing with fee leveling arrangements, however, is on the fees and compensation charged for investment advice. Accordingly, the final rules 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.

The final 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 varies depending on the basis of the participant's or beneficiary's selection of an investment option. Thus, the level fee and compensation limitations do not apply to affiliates of a fiduciary adviser.

Computer model for investment advice. Investment advice may be provided under an eligible investment advice arrangement that uses a qualified computer model that is certified to be objective and unbiased. Note, the advice generated by the computer model must be the only investment advice provided and may not be supplemented by the fiduciary adviser with additional individualized advice.

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. appropriately weigh the factors used in estimating future returns on investment options;
4. 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;
5. be designed and operated to use appropriate objective criteria to provide asset allocation portfolios comprised of investment options available under the plan;
6. avoid investment recommendations that inappropriately favor investment options: (i) offered by the fiduciary adviser (or person with a material affiliation or material contractual relationship with the fiduciary adviser) over other investment options under the plan, or (ii) that may generate income for the fiduciary adviser (or those with a material affiliation or material contractual relationship with the fiduciary adviser); and
7. take into account all designated investment options under the plan without giving inappropriate weight to any investment option.

CCH Note: Designated investment options, for purposes of the statutory exemption, do not include brokerage windows, self-directed brokerage accounts, or similar arrangements that enable participants and beneficiaries to select investment options beyond those designated by the plan.

Persons would have a "material" contractual relationship if payments made by one person to the other pursuant to a contract or agreement (whether or not written) exceed 10 percent of the gross revenue, on an annual basis, of the other person. A person (affiliate) would have a "material affiliation" with another person if it directly or indirectly owned, controlled, or held 5 percent or more of the interests of the person; or if 5 percent of more of its interest (e.g., combined voting power of all classes of stock entitled to vote or the total value of all classes of shares of a corporation) were directly or indirectly owned, controlled, or held by the other person.

Under the proposed regulations, computer models would not be required to take into account an investment option that constituted an investment primarily in qualifying employer securities. In the final regulations, however, the DOL has removed qualifying employer securities from the list of excepted options. According to the DOL, computer models can be designed to address investments in qualifying employer securities and such advice can significantly benefit plan participants.

The proposed regulations also provided an exemption for investments that allocate the invested assets of a participant or beneficiary to achieve varying degrees of long-term appreciation and capital preservation through equity and fixed income exposures, based on a defined time horizon or on the level of risk of the participant or beneficiary (e.g., target date funds). The DOL, in the final regulations, however removed the exemption for asset allocation funds.

The proposed regulations allowed a computer model to disregard in-plan annuity options that allow a participant or beneficiary to allocate assets toward the purchase of a stream of retirement income payments guaranteed by an insurance company. The final regulations retain the exception for in-plan annuity products. Thus, a computer model is not required to (but may) make recommendations with respect to the acquisition, holding, or sale of such annuity options. However, contemporaneous with the provision of investment advice generated by the computer model, participants and beneficiaries would need to be provided with a general description of the annuity options and how they operate. In addition, the DOL cautions that the computer model must take into account amounts that participants or beneficiaries have already allocated to an in-plan annuity in developing recommendations for the investment of the participant's remaining assets.

While the computer model should model all investment options under the plan (or IRA), it is not required to model the whole universe of investment options. Thus, the model may limit buy recommendations to those investment options that may be bought through the plan (or IRA). However, the plan participant or IRA beneficiary must be fully informed of the model's limitations prior to receiving the recommendations.

The fiduciary adviser, prior to using the computer model, is required to obtain a written certification (performed by an eligible investment expert) that the model satisfies the governing conditions set forth in the regulations. An eligible investment expert would be a person that, through employees or otherwise, possesses the appropriate technical training or experience and proficiency needed to analyze, determine, and certify whether a computer model meets the governing requirements. However, an eligible investment expert may not have a 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 an employee agent or registered representative of the foregoing. Accordingly, incident to this requirement, the regulations preclude a person who developed the computer model utilized by the fiduciary adviser from being authorized to certify the model.

Program must be authorized by separate plan fiduciary

An eligible investment advice arrangement must be expressly authorized by a plan fiduciary (or the beneficiary of the IRA). The arrangement may 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. Note, however, an IRA beneficiary will not be treated as an affiliate of a person merely because the beneficiary is an employee of the fiduciary adviser.

A plan sponsor may not, under the final rules, be treated as providing a designated investment option solely because one of the designated investment options of the plan allows investment in the securities of the sponsor or an affiliate. Thus, a plan sponsor fiduciary may authorize an eligible investment advice arrangement even if the plan includes qualifying employer securities as a designated investment option.

A fiduciary adviser may effectively provide advice to its own employees (or employees of an affiliate) by providing the required authorization. However, the fiduciary adviser or affiliate must offer the same arrangements to participants and beneficiaries of unaffiliated plans in the ordinary course of its business. In addition, the fiduciary must prudently select the investment adviser or investment advice arrangement.

Annual audit of investment arrangement by independent auditor

The fiduciary adviser must at least annually engage a qualified independent auditor to conduct an audit of the investment advice arrangement to ensure that it meets the requirements of the PT exemption. The specific findings of the audit must be disclosed within 60 days in a written report to the adviser and (with the exception of arrangements within an IRA) to each fiduciary who authorized use of the arrangement.

The final regulations expand upon the proposed rules by specifying the information that must be included in the audit report. The report must: identify the fiduciary adviser; indicate whether the arrangement is a fee leveling or computer model (or both) type; and provide the date of the most recent computer model certification, identifying the eligible investment expert that provided the certification.

The fiduciary adviser is charged with determining whether an eligible investment expert possesses the requisite training and experience to evaluate whether a computer model meets the regulatory requirements. The DOL cautions fiduciary advisers that the selection of the auditor, similar to the selection of the eligible investment expert, is a fiduciary act subject to the requirements of ERISA §404(a)(1). The mere performance of the audit will not cause the auditor to be treated as a fiduciary.

Required disclosures to participants and beneficiaries

Prior to providing investment advice about securities or other property offered as an investment option, the fiduciary adviser must (without charge) furnish a participant or beneficiary with written notification (which may be in electronic form), disclosing (in a clear and conspicuous manner) the following:

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; and (c) any rollover or other 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;
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.

The final regulations provide a model form that may be used by fiduciary advisers in order to satisfy the fee and compensation disclosure requirements.

The information required to be disclosed in the notice must be maintained in an accurate, up-to-date form by the fiduciary adviser at all times that the advisory services are being provided to plan participants or beneficiaries. In addition, the information must be furnished to the recipient of the advice, without charge, at least annually or upon request.

Disclosures to authorizing fiduciary

The final regulations expand upon the proposed regulations by requiring fiduciary advisers to provide a written notice to the fiduciary authorizing the arrangement, informing the fiduciary that:

1. the fiduciary adviser intends to comply with the conditions of the statutory exemption for investment advice;
2. the fiduciary adviser's arrangement will be audited annually for compliance with the requirements of the statutory exemption; and
3. the auditor will furnish the authorizing fiduciary with a copy of the auditor's findings within 60 days of the completion of the audit.

Disclosure rules applicable to investment transactions

Fiduciary advisers are subject to disclosure rules and other conditions with respect to a specific sale, acquisition, or holding of the security or other property (investment transactions).

The adviser is required to disclose any fees or other compensation the adviser or its affiliates are to receive in connection with an investment transaction. The disclosures would need to comply with all relevant securities laws.

In addition, under the rules: (1) the sale, acquisition, or holding must occur solely at the direction of the participant or beneficiary receiving the advice; (2) any compensation received by the adviser and affiliates thereof in connection with the investment transaction must be reasonable; and (3) the terms of the investment transaction must be no less favorable to the plan than those under an arm's length transaction.

Maintain evidence of compliance for six years

The fiduciary adviser who has provided investment advice under an eligible investment advice arrangement (pursuant to the statutory exemption), would need to maintain any records necessary for determining whether the prohibited transaction exemption requirements were met for at least six years after providing the investment advice.

Source: EBSA final regulations, 76 FR 66136, October 25, 2011.

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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