DOL Issues Proposed Regulation to Increase Workers' Access to High Quality Investment Advice

The Pension Protection Act of 2006 (“PPA”) amended the Employee Retirement Income Security Act of 1974 (“ERISA”) to create a new statutory exemption from the prohibited transaction rules to expand the availability of investment advice to participants in 401(k)-type plans and individual retirement accounts (“IRAs”), subject to safeguards and conditions. The Department of Labor (“DOL”) announced on February 26, 2010 that it is publishing in the Federal Register a proposed rule to implement these PPA provisions and make investment advice more accessible for millions of Americans in 401(k) type plans and IRAs.

According to DOL’s notice, as of 2007, more than one-half of private-sector employees participated in defined contribution plans that allow for participant direction, with these plans covering 60 million active participants and holding about $3 trillion in assets. In general, investment advice given by an investment adviser to plan participants on investments that pay additional fees to the adviser or its affiliates can violate the prohibited transaction rules of ERISA and the Internal Revenue Code. This has limited the types of investment advice arrangements available to participants in 401(k) plans and IRAs. Given the rise in participation in 401(k) type plans and IRAs, the retirement security of millions of America’s workers increasingly depends on their investment decisions. Thus, there is increased recognition of the importance of investment advice in helping participants avoid costly investment errors.

The proposed regulation allows investment advice to be given under the statutory exemption in two ways: (1) through the use of a computer model certified as “unbiased”; or (2) through an adviser compensated on a “level-fee” basis (meaning that fees do not vary based on investments selected by the participant). Several other requirements also must be satisfied, including disclosure of fees the adviser is to receive. The regulation contains some key safeguards and conditions, including: (a) requiring that a plan fiduciary (independent of the investment adviser or its affiliates) select the computer model or fee leveling investment advice arrangement; (b) imposing recordkeeping requirements for investment advisers relying on the exemption for computer model or fee leveling advice arrangements; (c) requiring that computer models must be certified in advance as unbiased and meeting the exemption’s requirements by an independent expert; (d) establishing qualifications and a selection process for the investment expert who must perform the above certification; (e) clarifying that the fee-leveling requirements do not permit investment advisers (including its employees) to receive compensation from affiliates on the basis of their recommendations; (e) establishing an annual audit of investment advice arrangements, including the requirement that the auditor be independent from the investment advice provider; and (f) requiring disclosures by advisers to plan participants.

The Department published the proposed regulation in the Federal Register on March 2, 2010. The Notice of Proposed Rulemaking (NPRM) invites public comments from interested persons on the proposed regulation’s conditions applicable to investment advice arrangements.