Saturday, July 11, 2020

Benefits Briefing: 'Conflicted' Retirement Advice

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Coordinated Benefits Group

(904) 281-0511

Both the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (the Code) generally prohibit fiduciary investment advisers from receiving compensation from the investment vehicles that they recommend to plan participants and IRA holders.  However, the Pension Protection Act of 2006 amended ERISA to create a new statutory exemption from the prohibited transaction rules that is designed to expand the availability of fiduciary investment advice to participants in individual account plans and IRAs, subject to specific safeguards and conditions.

Although this statutory exemption has been in effect since 2007, it has taken several years for the Department of Labor (DOL) to draft appropriate regulatory guidance.  Final regulations implementing the statutory exemption were published in January of 2009, but they were delayed several times and then eventually withdrawn.  Significantly revised regulations were re-proposed in March of 2010, and they were finalized, with minor modifications, on Oct. 24, 2011.  These final regulations will become effective on Dec. 27, 2011 - applying to transactions occurring on or after that date.

What is "Conflicted" Investment Advice?
Under ERISA, a "fiduciary" includes any entity or individual who renders investment advice for a fee (or other direct or indirect compensation) with respect to the assets of an ERISA-covered plan, or that has any authority or responsibility to do so. 

A fiduciary is then prohibited from dealing with the assets of a plan in its own interest or for its own account, and from receiving any consideration for its own personal account from any party dealing with the plan in connection with a transaction involving the assets of a plan.

These "self-dealing" prohibitions have been interpreted as barring a fiduciary from using the authority, control, or responsibility that makes it a fiduciary to cause itself (or a party in which it has an interest that may affect its best judgment as a fiduciary) to receive additional fees.  Consequently, fiduciaries are generally prohibited from rendering investment advice to participants with respect to investments that result in the payment of additional advisory or other fees to the fiduciary or its affiliates.  Similar rules apply under the Code to the rendering of investment advice to IRA holders.

What Transactions are Covered by the Statutory Exemption?
Section 408(b)(14) of ERISA lists the transactions that are exempt from the prohibited transaction rules if certain requirements (described below) are met.  These transactions include:

  • The provision of investment advice to a participant or beneficiary with respect to an investment option that is available under the plan;
  • The acquisition, holding, or sale of an investment (i.e., an available investment option under the plan) pursuant to that investment advice; and
  • The direct or indirect receipt of compensation by a fiduciary adviser or affiliate in connection with the provision of that investment advice or the acquisition, holding, or sale of the investment.

What is an "Eligible Investment Advice Arrangement"?
Section 408(g) of ERISA provides that potentially conflicted advice will be exempt from the prohibited transaction rules only if it is provided by a fiduciary adviser under an "eligible investment advice arrangement."  There are two general types of eligible arrangements: a "fee-leveling" arrangement (where the fees do not vary based on the investments selected by the participant); and a "computer model" arrangement (requiring the use of certified computer-generated asset allocation models).  Both types of arrangements must also satisfy several other requirements.

To qualify as a "fee leveling" arrangement, the fiduciary advisor must:

  • Base the advice on generally accepted investment theories that take into account several types of data/information;
  • Take into account investment management and other fees and expenses of the investments;
  • Request, and take into account to the extent furnished, individual information about the participant (such as age, risk tolerance, etc.); and
  • Not receive compensation that varies on the basis of the participant's selection of a particular investment option.

Obviously, the last of these four conditions is the key; the advisor must not have a financial bias in recommending any particular investment option.  This includes any direct or indirect compensation that the advisor may receive in connection with the participant's selection of that investment.  However, it does not include compensation payable to an affiliate of the advisor.  Therefore, an advisor may in fact recommend funds sponsored by (or that share revenue with) an affiliate of the advisor, so long as the advisor does not receive any greater compensation with respect to those funds than it does with respect to any other investment option offered under the plan.  (This should be compared to the more restrictive rule for "computer model" arrangements, as discussed below.)

To qualify as a "computer model" arrangement, the following requirements must be met:


  • The model must apply generally accepted investment theories that take into account several listed types of data/information;
  • The model must take into account the investment management and other fees and expenses associated with the recommended investments;
  • The model must appropriately weight the factors used in estimating future returns;
  • The arrangement must request, and take into account to the extent furnished, certain information about the participant (age, risk tolerance, etc.);
  • The model must utilize appropriate objective criteria to provide asset allocation portfolios composed of the investment options available under the plan;
  • The recommended portfolios must not inappropriately favor the options offered by, or options that may generate greater income for, the fiduciary advisor or any entity with a "material affiliation" or "material contractual relationship" with the advisor (as those terms are defined in the regulations); and
  • The model must take into account all designated investment options under the plan, without giving inappropriate weight to any particular option.

Under either a "fee leveling" or a "computer model" arrangement, the advisor must (in addition to the above requirements): 

  • Obtain a plan fiduciary's prior authorization of the arrangement;
  • Arrange for an annual audit of the arrangement;
  • Provide certain written disclosures to participants;
  • Provide certain written disclosures to the authorizing fiduciary;
  • Provide appropriate disclosures in accordance with all applicable securities laws;
  • Ensure that any sale or acquisition occurs solely at the direction of the recipient of the advice;
  • Receive no more than "reasonable" compensation;
  • Ensure that the terms of any sale or acquisition are at least as favorable to the plan as an arm's-length transaction would be; and
  • Maintain records, for not less than six years, sufficient to demonstrate compliance with the regulations.

Do the Regulations Make Prior DOL Guidance on Investment Advice Obsolete?
No.  The final regulations specifically provide that nothing in Section 408(g) of ERISA, Section 4975 of the Code, or the final regulations invalidates or otherwise affects prior regulations, exemptions, or interpretive or other guidance issued by the DOL pertaining to the provision of investment advice and the circumstances under which that advice may or may not constitute a prohibited transaction under ERISA or the Code.  Such prior guidance includes Advisory Opinion 2001-09A (the "SunAmerica" opinion), which allows potentially conflicted advisors to provide advice that is based on investment-specific asset allocation portfolios created by an independent third-party fiduciary advisor.

Are Plan Sponsors Required to Provide Investment Advice?
No.  Neither a plan sponsor nor an investment provider is required to provide fiduciary investment advice.  The DOL has issued guidance (in Interpretive Bulletin 96-1) setting forth the types of "investment education" that employers and/or service providers may provide without that education being treated as fiduciary investment advice.  That guidance - which allows a plan's broker or investment provider to provide asset allocation assistance, so long as the recommendations are limited to categories of investments (such as large-cap growth or international funds) rather than specific investment options - is not affected by these new regulations.

However, if a plan's investment provider (or any other service provider or advisor with a financial interest in the investment options available under the plan) provides advice to plan participants that involves the recommendation of specific investment options, that advice must be provided under an "eligible investment advice arrangement" meeting the requirements of these new regulations.             

Robert A. Browning, Partner
Spencer Fane Britt & Browne LLP
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