United States: U.S. Department of Labor Issues Updated Proposed Investment Advice Regulations

The Department of Labor has issued new proposed regulations for the provision of investment advice to participants in individual account plans and owners of IRAs. The regulations will affect many aspects of plan administration. Plan sponsors, financial service providers and plan fiduciaries should take action in preparation for compliance with the requirements under the proposed regulations.

The U.S. Department of Labor (DOL) has released new proposed regulations for the provision of investment advice to participants in individual account plans and owners of IRAs. The proposed regulations interpret the statutory prohibited transaction exemption for investment advice enacted under the Pension Protection Act of 2006 (PPA), which allows investment advice under a fee-leveling arrangement or a computer model arrangement.

The new proposed regulations mark the second time the DOL has issued regulations for the investment advice exemption. It previously issued final regulations on January 21, 2009, but they were withdrawn on November 20, 2009, after receiving several comments. The recently released proposed regulations contain the terms of the withdrawn final regulations—with a few important modifications.

The proposed regulations state the provisions will be effective 60 days after they are issued in final form. Phyllis C. Borzi, assistant secretary of the DOL Employee Benefits Security Administration, has publicly stated that the administration hopes to finalize the proposed regulations soon.

Background on Investment Advice Regulation

In general, ERISA prohibits certain transactions involving plan assets. Among these transactions, an investment advisor is prohibited from having a conflict of interest, self-dealing or recommending an investment that may cause the advisor, or any person or entity in which the advisor has a material interest, to receive additional compensation. In recent years, as participant-directed investments have become the norm, the DOL has created exceptions to the general prohibited transaction rules that identify circumstances in which providing investment advice to participants will not be deemed a prohibited transaction. The DOL issued an advisory opinion stating that there is no prohibited transaction if investment advice is outsourced to an independent financial expert using a computerized investment model. This is generally referred to as the "Sun America" approach. In addition, the DOL has created an administrative prohibited transaction exemption that applies if the amount paid to an advisor for advice is reduced by the fees or other economic benefits accrued to the advisor or its affiliate by reason of the investment choices made under the plan. This is generally known as the "fee-leveling" approach.

Investment Advice under the PPA

Although the DOL had issued some relief for the provision of investment advice, Congress enacted additional statutory relief under the PPA. The PPA amended ERISA to provide a statutory prohibited transaction exemption for advice given with respect to investments available under a plan and for the payment of fees in connection with giving investment advice. The statutory prohibited transaction exemption is available only if the investment advice is given through an "eligible investment advice arrangement." Investment advice is given under an eligible investment advice if it is provided under an arrangement that is either a fee-leveling arrangement or a computer model arrangement. Under a fee-leveling arrangement, any fees received by the investment advisor do not vary based on the investment option selected. Under a computer model arrangement, a computer model certified by an independent third party is used under an investment advice program. Specific regulatory requirements apply to fee‑leveling arrangements and computer model arrangements.

In addition to satisfying the regulatory requirements applicable to a fee-leveling arrangement or a computer model arrangement, all eligible investment advice arrangements must meet certain other requirements. An arrangement must be authorized by a plan fiduciary and annually audited by an independent auditor. In addition, an arrangement must be disclosed to participants in a comprehensive written notification that is understandable by the average plan participant.

New Proposed Regulations

Complex regulatory requirements accompany the statutory requirements. Compliance with both is required for investment advice to be exempt from the prohibited transaction rules under the PPA. The DOL previously released final regulations for the statutory exemption under the PPA, but they were withdrawn. After the withdrawal of the final regulations, the DOL issued new proposed regulations that are very similar to the withdrawn final regulations. Both the withdrawn final regulations and proposed regulations, for example, include a sample disclosure notice and clarify that the statutory exemption does not repeal any prior DOL guidance on investment advice. There are, however, a few important differences between the withdrawn final regulations and the new proposed regulations. The differences between the two sets of regulations are due to lingering issues raised by commentators.

Class Exemption

The proposed regulations do not include the class exemption that was part of the withdrawn final regulations. The DOL received several comments about the class exemption being overbroad and creating potential conflicts of interest. The withdrawn final regulations would have allowed an advisor to provide individualized advice if a person asked for more advice after receiving the computer model advice. Under the proposed regulations, such "off-model advice" is permitted only to the extent that such advice separately satisfies the prohibited transaction rules. For off-model advice to be exempt under the PPA's statutory prohibited transaction exemption, it must be generated by a computer model or rendered under a fee-leveling arrangement and satisfy the extensive regulatory requirements.

Fee-Leveling Arrangements

The fee-leveling arrangement provisions in the proposed regulations are very similar to the withdrawn final regulations. The proposed regulations clarified one particular provision in the withdrawn final regulations. Under the withdrawn final regulations, fees received by an investment advisor—or by an employee, agent or registered representative who provides investment advice on behalf of an investment advisor—for providing investment advice could not vary depending on the basis of any investment option selected by a participant or beneficiary. In addition, fees received by an employee, agent or registered representative who provides investment advice on behalf of an investment advisor could not vary depending on the investment option selected by a participant.

Commentators, however, identified a flaw in the final regulations. The final regulations did not clearly prohibit fees received by an affiliate of the investment advisor from flowing through to the investment advisor or to its employee, agent or registered representative. The proposed regulations fix this loophole by prohibiting fees from flowing from an affiliate of the investment advisor to the investment advisor or another related party. Put another way, the investment advisor or individuals providing investment advice cannot receive economic incentives from an affiliate who receives variable fees.

Computer Model Arrangement

The computer model arrangement provisions under the proposed regulations add a new requirement not included in the withdrawn final regulations. The proposed regulations require the computer model to avoid investment recommendations within an asset class on the basis of factors that cannot be expected to persist in the future. The DOL suggests that some differences between investment options within a single asset class, such as differences in fees and expenses or management style, are likely to persist in the future and thus are appropriate criteria for an asset allocation assessment. The DOL, however, suggests that other differences, such as historical performance, are less likely to persist in the future and therefore are less likely to constitute appropriate criteria for asset allocation assessment.

Generally Accepted Investment Theories

The proposed regulations require advice under either a fee-leveling arrangement or a computer model arrangement to be based on "generally accepted investment theories." Until now, the DOL has avoided trying to define investment criteria. The preamble to the proposed regulations suggests that the DOL will attempt to define these terms. The DOL specifically solicited comments from interested persons on what practices should be considered generally accepted investment theories and what historical investment information is appropriate to assess. The period for submitting comments closed on May 5, 2010.


Plan sponsors, financial service providers and plan fiduciaries should take action in preparation for compliance with the requirements under the proposed regulations. The investment advice regulations will affect many aspects of plan administration, including investment advice procedures, investment policy statements and service provider agreements, and will require care in complying with various new requirements, including new participant disclosures.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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